This article explains two alternative funding options for real estate IRAs. A low account balance doesn’t mean you can’t take advantage of the IRA strategy. It simply means that you’ll need to be more creative when exploring your options!
Remember, you can always transfer funds from an existing retirement account, such as an old employer’s 401(k), into a self-directed IRA. If you’ve been saving for years, this transfer should give you a nice cash cushion to use to start investing in real estate. If you’re still lacking funds after a transfer, these methods should help you get moving.
One popular way to fund real estate investments is to partner up with other funding sources. You can partner your IRA with other IRAs, individual investors, or LLCs.
When purchasing a new asset, you can even partner with disqualified persons, such as a spouse or your own personal funds, to expand your purchasing power.
The important thing to remember when partnering on an investment is that the initial division of ownership must remain consistent throughout management of the asset.
For example, if you partner your self-directed IRA with three other IRAs to purchase a property, with each IRA owning a 25% stake in the property, that ratio must be upheld on all future transactions. In other words, each IRA will be responsible for 25% of the costs and expenses that arise, and each IRA will collect 25% of any profits generated from the real estate investment.
To learn more about the partnering strategy, check out this free report: Partnering Self-Directed IRAs
2. Non-Recourse Loans
Another real estate IRA funding option is to use leverage by securing a non-recourse loan, though these are harder to come by now that banks have tightened their lending purses.
A non-recourse loan requires a pledge of collateral, which could be the property you are pursuing. If you default on the loan, the lending institution can take ownership of the property, but they will not be able to target the IRA’s funds or other assets in pursuit of debt collection.
The IRS approves of IRAs using leverage, however, it doesn’t approve of offering the same tax advantages to leveraged funds within an IRA. In other words, using a non-recourse loan could mean paying UDFI (Unrelated Debt-Financed Income) taxes. The IRS will collect UDFI taxes on any retirement account income that came from the use of borrowed cash.
For example, if you use a non-recourse loan to cover 50% of purchasing costs on a real estate investment, the IRS will tax 50% of the income generated by that property. The UDFI tax ranges from 15-38%, depending on the situation. Consult a tax professional if you have specific questions about how UDFI may affect your investments.
UDFI taxes do not apply to investors using a self-directed Individual (k), also called the Solo 401(k). These retirement arrangements, designed for sole-proprietors or business owners that work solely with a spouse, are exempt from UDFI taxation.
If you were hesitant to start investing in real estate with a self-directed IRA, now you have two strategies in your pocket that will increase your purchasing power. Remember, you’re not restricted to property investments within a self-directed IRA. Accounts with lower balances can invest in notes, tax liens, or real estate options until enough cash is available to upgrade to physical property.
Explore all angles before deciding which approach is best for you and your retirement! Questions welcomed.