Real estate investing can be a lucrative opportunity, particularly as property values continue to rise. However, some may require upfront investments to secure property ownership. And while your self-directed IRA, Solo 401(k), or Health Savings Account may have grown, you may still find yourself short of the funds needed to purchase real estate outright.
Ready to purchase investment properties with your self-directed account? Click here to access our easy online new account application.
Fortunately, tax-advantaged account investing can employ acquisition financing. This enables you to acquire more or bigger properties with the same amount of equity capital. So how does this work?
A retirement account can obtain a non-recourse loan, meaning you cannot secure the loan with your personal funds or collateral. Only the investment itself—in this case, the real estate property—may secure the loan. Apart from this difference, an account-owned mortgage will work the same way as a “regular” mortgage.
Many well-known financial institutions issue non-recourse loans, but you could also seek private financing. Keep this in mind when considering your investment options: if you are not interested in investing in real estate outright, your account can act as a private lender for other real estate investors.
Using Debt to Purchase One Property…or Several
Thanks to financing, your account can purchase a property it couldn’t otherwise afford. You could also spread your account capital around to acquire multiple properties.
For instance, let’s say your account has $75,000 in cash. It may not be enough to buy a property in full, but your account could take out a non-recourse loan for the shortfall. Or, if you’re feeling ambitious and have a lengthy list of opportunities, you could put $25,000 down on three separate properties and finance the rest. Now your portfolio has three investments instead of one. If your risk tolerance allows for this aggressive approach, you can reduce the time needed to build an impressive portfolio of assets.
Unrelated Business Income Tax (UBIT)
Real estate earnings attributable to debt may trigger UBIT. If we return to our previous example, let’s assume you elect to purchase a property valued at $150,000. You use your account’s $75,000 in cash and a $75,000 loan. This would constitute a debt-financed percentage of 50%. Accordingly, 50% of the property’s earnings would be subject to UBIT, though deductions, depreciation, and a statutory exemption would apply. UBIT owed is often much smaller than many realize, and, as the loan is paid down, the debt percentage will decrease and likely reduce future UBIT obligations.
NDTCO created a UBIT Calculator to help clients estimate potential UBIT that may result from using leverage. Click here to access our easy downloadable* calculator.
You may wonder why your tax-advantaged plan would have to pay taxes at all. Remember that UBIT is not an IRS penalty but a tax on using non-retirement funds (i.e., the debt that was not subject to annual contribution limits) along with tax-advantaged funds. Without UBIT, the return on a leveraged property could be seen as a “back door contribution” into a retirement account.
Knowledge Is Power
Self-direction already affords a great deal of flexibility to invest in the assets you know, and harnessing the power of debt can take your money-making capabilities even further. Don’t hesitate to give NDTCO a call at 877-742-1270 or send us a message through the Client Portal if you have questions about real estate investments.
*The file does contain macros.