Can I Borrow Money Through My IRA To Buy Real Estate?
Yes, you can borrow money in your IRA to buy real estate, or practically anything else. How's that for a simple answer?
BUT... there are some very important details to consider.
First, it can’t be just any loan. There are some very specific requirements in order to avoid committing a dreaded “prohibited transaction”.
So what kind of loan works well for this purpose?
What you need is a loan in which the lender can do nothing more than perform a foreclosure against the property in the event of default. In other words, it must not be possible for the IRA to be legally liable for the debt in any way beyond providing the property as collateral.
That’s what they call a “non-recourse” loan. These loans are actually a bit higher risk for lenders. As such, these loans usually come at a higher interest rate and require a larger down payment than normal loans. 20-40% down is a pretty common down payment requirement. Plus, many lenders will want you to have some reserves in your IRA to cover payments
(Important warning: Before you take out any loan in your IRA, even if it is specifically marketed as a "non-recourse" loan, get the loan documents reviewed by a qualified ERISA attorney to confirm compliance. These days, many of these loans contain provisions called "carve-outs" which are basically just fine print that eliminates the non-recourse provisions under certain circumstances, which causes the loan to be incompatible with your IRA... but the lenders won't likely tell you this themselves.)
Second, the IRA itself must make all of the payments for the loan. You can not pay those payments directly. Additionally, all of the proceeds of the loan are usable only by the IRA. You can't use that money personally at all. Remember: This is a loan for your IRA, not for you.
Third, if the lender requires a co-signer, the co-signer must not be a disqualified party. In other words, practically, they can't be you, anyone related to you, or any entities that you have any control or influence over. There's a lot more about disqualified parties here.
Fourth, if your IRA borrows from someone you know, don't play any games. Make sure that your IRA pays a reasonable rate for the capital... not too much, and not too little. If your IRA should borrow money from someone you know under terms that are not reasonable based on market levels, the transaction could face IRS scrutiny.
Fifth, With an IRA, your IRA will likely to be liable to file an annual income tax return and for payment of income taxes each year based on the transaction's debt ratio. A substantially over-simplified example works like this: If you borrowed 80% of the money to make the investment, then your IRA has to pay taxes on 80% of the profits. So if you made $100,000 in profit, you’d have to pay taxes on $80,000.
What's worse, your tax will be payable at trust rates (which are higher than income tax rates) since your IRA is legally just a specialized type of trust. It’s kind of a raw deal… but still, better than not being able to do the deal at all.
Sixth, if you must get a loan in your IRA, find out if you qualify for a solo 401(k) and do the deal there instead. That's because one of the perks of a solo 401(k) versus a self-directed IRA is that the income taxes that an IRA must pay when using a loan apply only to IRA's and not to 401k's... this difference could be truly substantial.