subject: Understanding Self-Directed IRAs and IRA Loans [print this page] Understanding Self-Directed IRAs and IRA Loans
When it comes to investing with self-directed IRAs, particularly real estate IRAs, many people find themselves in a bit of a predicament. They have found a good piece of property that they would like to use their IRA fund to invest in. However, they don't have enough money to cover the entire cost of purchasing the property. This often happens to people who do not have ample funds in their IRA or who cannot go into investment partnerships with anyone and split the investment costs. In these cases, it is still possible to purchase real estate in an IRA with the help of IRA loans. It's important to understand that these loans work a little differently than conventional loans.
IRA Loans Get You a Mortgage
IRA loans are also known as non recourse loans. To understand how this type of loan works, it helps to be clear about how self-directed IRAs work. When you use your IRA funds to make an investment, the investment technically belongs to the account, not you. This is in keeping with IRS regulations that state you cannot immediately benefit from the funds in your IRA. In other words, you can use the funds to purchase a new home, but you cannot move into or collect rent personally on that house until you reach retirement age and claim the home as a retirement benefit.
When taking out a mortgage with a self-directed IRA, the same basic principle applies. The loan is made out to your IRA account, not to you. This is an important point to remember since in these cases, the property itself is put up as collateral. If your account should default on IRA loan's payment, the lender will not be able to touch the funds in your IRA. Instead, the property is their only recourse.
What This Means for You
These kinds of IRA loans do have their own risks. For instance, the lender runs a risk with these loans since they do not have any guaranteed personal collateral. As a result, they may charge higher interest rates and down payments. The higher interest rate and/or down payment is to ensure that in the case of default, the lender will still be able to make a profit while having enough equity for foreclosing and sale costs. These IRA loans also contain an unrelated debt-financed income tax. In spite of these factors, opting for this kind of financing can still help to turn you a profit. For example, let's assume that your self-directed IRA takes out a loan on seventy percent of the purchase price of a piece of real estate. This seventy percent will be subject to unrelated debt-financed income taxation. The remaining thirty percent of the property belongs to your IRA. In other words, it has tax-deferred status. This can reduce your entire tax burden considerably when you consider the overall ratio of debt of the property. In other words, it's still possible to make a profit, in spite of the taxation.
It's clear that IRA loans can be very helpful when it comes to making an investment with a self-directed IRA. As with all investments, they need to be made properly to ensure that your IRA still generates a profit from the investment. It's important to speak with your financial consultant first to find out the best way to invest your self-directed IRA.
