The IRS requires a non-recourse loan for all real estate purchases that use leverage within a self-directed IRA. The difference between recourse and non-recourse loans is that in a non-recourse loan, if the borrower defaults, the lender/issuer can seize only the collateral, which is usually the property. Non-recourse debt is typically limited to a 50-60 percent loan-to-value ratios.
A non-recourse loan is a loan in which you, as the IRA holder, are not personally liable for repaying the loan. Once you locate a lender/bank, the lender will lend to your IRA, not to you as an individual. The lender will have no recourse against you or the balance of your IRA funds in the event of a default. The lender will only be able to recover the property and your equity. In a non-recourse loan, you may not use your personal credit to facilitate the loan.
Unrelated Debt Financed Income (UDFI) is covered in IRC 514. If you are using your IRA and a non-recourse loan to purchase property, the debt financing transaction will subject the IRA to UDFI. In this case, taxes are based on the highest amount of leverage the self-directed IRA carried in the past 12 months. UDFI must be paid by the IRA and does not apply if the debt had been paid off for 12 months or more.
If your IRA does owe UDFI, it is best to consult a tax professional to prepare IRS Form 990-T. Once complete, you can submit the Form 990-T to Entrust with your authorization to file and pay the UDFI tax. To find out more about UDFI, please see IRS publication 598 or speak with your tax advisor.
The above information is NOT intended to be tax or legal advice, as Entrust does not provide legal and/or tax advice. It is designed only to educate investors and to help factor in variables when making investment decisions.