a BIG LIE: Why Your IRA is NOT Limited To Using Non-Recourse Loans [EPISODE #149]
Interested in borrowing money in your IRA to do bigger deals? Have you been told you’ve got to use a Non-Recourse loan? THINK AGAIN… It’s just not true! In fact… I’ll tell you why even some “Non-Recourse” loans don’t even qualify for use in an IRA. I’m Bryan Ellis. I’ll tell you the brutal details RIGHT NOW in Episode 149 of Self Directed Investor Talk.
Hello, SDI Nation! Welcome to the podcast of record for SAVVY self-directed investors like you!
There’s been a whirlwind of activity here at SDI Headquarters. We’re doing a lot of great deals with our clients and we’ve got a couple of really, really solid multifamily properties that, frankly, are truly solid deals – one of them a 5-unit building in the $250,000 price range and a 12-unit building around $800K. Both fully renovated with highly reliable cash flows and double digit cap rates… a beautiful, beautiful thing. Plus, you might recall a couple of weeks ago when I had 19 GREAT fully turnkey single-family properties available for purchase, and all 19 of them were snapped up within about a week? Well, one of those is available again due to an unfortunate situation for the former buyer… and this is a good one! Get this – the pro forma suggests you can get a solid 11.5% cash-on-cash return AFTER factoring out property taxes, insurance, management fees and even maintenance expenses! And this property will only cost you $49,900 to get into it… that’s not the down payment, that’s the entire price! So some really, really awesome opportunities available right now, for a very brief time.
If that sort of thing gets your attention – as well it should – then let me know – and quick! Just go over to SDIRadio.com/consultation and set up a time to talk with me.
My friends… there’s a rumor going around. This one is pervasive. It goes something like this:
If your IRA borrows money, it must use a “non-recourse” loan.
You ever heard that one? It’s almost true… but very, very wrong.
For those of you who may not know, a “non-recourse” loan is one in which the lender’s only recourse if the borrower defaults is to foreclose the property. The lender isn’t allowed to sue the borrower or take any action other than to foreclose the property. These loans aren’t generally available at local banks or big lenders. They’re the domain of specialty lenders who cater
That’s the reason that the “non-recourse” fable is so prominent among self-directed IRA custodians and account holders. You’re not allowed to use your IRA as collateral for a loan or other extensions of credit. To do so is a prohibited transaction, and would totally blow up the account.
But nowhere in the tax code – that I am aware of – is there any indication that the only loans that can be utilized by an IRA are non-recourse loans. What is clear is that neither the IRA itself nor the owner of the IRA is allowed to accept liability for such loans.
But that leaves… oh, let me see… nearly EVERYBODY ELSE IN THE ENTIRE WORLD! Here’s what I mean:
What if you could get some unrelated third party to acquire financing for a deal in your place? Maybe a close friend or a business colleague would serve as something of a “credit partner” and allow you to essentially “rent” their credit from them. You’d do something like pay the third party a fee, and in exchange, they’d get a loan for your deal that is more favorable or more legally compatible with your IRA than anything you could get yourself.
In that case, the loan is absolutely NOT a “non-recourse” loan. The lender could take the property – which is pledged as collateral – if your IRA defaulted, but that lender could also pursue judgments or other recourse. But that recourse would be against the CREDIT PARTNER, and not against your IRA.
So there you have it: Use of a full-recourse loan that does not violate the requirements of your IRA.
And this isn’t just a neat idea without practical value. Here’s a simple example of why: Most non-recourse loans that are suitable for your IRA are more expensive than the same loan would be if it was a normal full-recourse loan. Additionally, non-recourse loans can have some unusual terms and penalties that are not standard fare in full-recourse loans.
Thus it’s entirely plausible that it would be cheaper or otherwise more favorable for an IRA owner who needs funding to pay an unrelated third party a fee for them to acquire conventional full-recourse funding for the asset on behalf of the IRA. Frankly, it’s not much different than paying points on the front end of a loan to make the loan cheaper over its lifetime.
And you know, that’s not the only reason that you might consider avoiding non-recourse loans. There’s another, more sinister, reason. That reason is called a “carve-out”.
A carve-out is an exception to the “non-recourse” nature of a loan.
In other words, it’s possible – and rather common these days – for a loan to stipulate that the lender can’t pursue claims against the borrower… except for certain situations. Those situations are called “carve-outs” or “bad-boy guarantees”. They are exceptions for which the non-recourse provisions no longer apply.
Historically, carve-outs have been used to reclaim the ability to take action against the guarantor of a loan in the event that the guarantor commits an illegal act or fraudulent act, or if the guarantor does something to impair the lender’s claim against the collateral.
But increasingly, carve-outs are being used for very broad issues that, frankly, are, in my humble but entirely correct opinion, so vague as to put borrowers in real danger. For example, I’ve got a loan document in front of me this moment from North American Savings Bank, a non-recourse lender, which stipulates that the loan is non-recourse… unless the borrower is involved in “waste committed or permitted on the property”… and there is also recourse against the borrower for any fees involved in the loan which are neither principal nor interest.
Why does this matter?
Even though these things are contingencies, they still represent an extension of credit by the IRA, as the IRA is committing to cover those expenses in the event it is required to do so.
Why does it matter if your IRA extends credit?
That one is simple: That’s prohibited… yep, the good ole prohibited transaction… the one that irreparably blows up your account and subjects your account to Armageddon-like taxes, penalties and interest… all because you took out a “non recourse” loan which, it turns out, wasn’t really non-recourse at all.
So that little trick I told you at the beginning, where your IRA pays a 3rd party credit partner to get a conventional (and cheaper) loan to finance your deal… well, that’s sounding smarter and smarter all the time, isn’t it? Because in that case, your IRA is just paying a fee to your credit partner… but not signing on the dotted line for any loans with questionable terms that could blow up your account.
And one more word of warning: Generally speaking, you’re going to have to pay a proportionate amount of income tax from your IRA for any profits made from leveraged transactions. So, for example, if you do a deal for which you acquired a 90% loan, then roughly 90% of the profits will be taxable to your IRA. But with one simple change, you can probably eliminate that tax burden entirely. What is that change? Convert your account to a self-directed 401k instead, and suddenly, the income tax liability on the debt financed portion of your deal probably goes away entirely!
That’s all for today…
My friends, invest wisely today, and live well forever!
Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for affluent self-directed investors. He's also an expert in self-directed IRA's, solo 401k's and turnkey rental property investing... at least, that's what his wife tells him 🙂 He's a contributor to well-respected publications like TheStreet.com, Entrepreneur and ThinkRealty. Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.