critical: If the IRS gets wind that the IRA owner signed a personal guarantee or otherwise granted recourse to an IRA lender to foreclose on any collateral outside the collateral itself, the IRS could disallow the entire account. ADVANTAGES FOR THE CREDIT- CHALLENGED In some cases, the IRA owner’s personal credit score and history are not relevant to a lender. When assessing a potential IRA loan, the lender sometimes makes the decision entirely on the collateral itself and the cash flow it generates. Furthermore, the loan doesn’t show up on the account holder’s personal credit report in any way. It’s the IRA doing the borrowing, not the owner personally! So financing an investment within a real estate IRA will not affect the account holder’s ability to get a personal operating income that exceeds debt payments by at least 20 percent to 30 percent. However, hard money lenders typically underwrite using the asset itself, rather than the income generated from it, as a collateral for the loan. There is an important difference between the two approaches: A lender using a purely asset-based approach to underwriting, rather than income-based underwriting, can often lend money on properties that are not currently generating any positive cash flow at all. INSTITUTIONAL NON-RECOURSE LENDING Expect institutional lenders to look at the following factors: mortgage or other kind of loan. QUALIFYING FOR A SELF- DIRECTED IRA LOAN Lenders will often require net
more traditional non-recourse loans. TAX CONSIDERATIONS While profits made with an investor’s own money within IRAs are tax- deferred (or tax-free in the case of Roth IRAs), profits and earnings attributable to borrowed money are subject to a special tax called the unrelated debt income tax. When an IRA borrows money, it must pay taxes on profits and earnings generated by that debt finance. These profits and earnings are called unrelated debt-financed income. If the account owner has leveraged the property 50 percent, then he or she will have to pay income taxes on 50 percent of the profit. On the flip side, the IRA can write off the expenses related to the debt-financed portion, in this case 50 percent. The borrower will need to obtain a separate taxpayer identification number or EIN for his or her IRA or LLC within the IRA that is actually holding the property. The borrower must also file a Form 990-T, along with other relevant tax schedules. Important: Use money from within the IRA to pay any taxes due. It’s the IRA paying the tax, not the account owner personally. UDIT isn’t just applied to leveraged real estate. The tax applies to any business, enterprise or activity in a self- directed IRA that is financed with money borrowed from outside the account. EXCEPTION: ACQUISITION UDIT does not apply to the debt- financed portion of an asset if the non- recourse loan is obtained at the time the asset is acquired. •
• LTV value: 30 percent to 50 percent maximum loan-to-value. • Debt service coverage: Expect to provide a traditional lender with a pro forma cash flow projection showing income sufficient to cover the debt payments. • Reserves: Lenders will typically want to see about 15 percent of the value of the loan in reserves within the IRA as reserves, to cover short-term emergencies. • Value and quality of the collateral itself: HOA’s should also be fiscally sound, if applicable. If all four requirements are met, then the institutional lender typically approves the loan. PRIVATE NON-RECOURSE LENDING Self-directed IRA owners can also borrow from any number of private lenders, including individual lenders. Many IRA owners are scouring the earth looking for reasonably safe, secure loans to make with their own IRA money at competitive rates of interest. While institutional lenders usually have to stick close to specific lending criteria, private lenders have no such limitations. Investors and lenders alike are limited only by their imaginations. In all cases, however, the loan must be non-recourse. HARD MONEY LENDING Hard money lenders specialize in asset-based loans with shorter time horizons—typically not more than two to five years. Expect higher origination costs and higher interest rates than on
BY JIM HITT
Jim Hitt is the founder and Chief Executive Officer of American IRA, LLC. He has been working with real estate IRA and real estate 401(k) investors for over 30 years and has been self-directing his own IRA investments since 1982. He welcomes questions and inquiries from real estate investor-readers. 866-7500-IRA | www.americanira.com
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