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Real Estate Investing with Retirement Funds: The Good, the Bad, and the UDFI

Dec 5, 2018

Today’s savvy investors are looking to tap into their retirement funds to invest into the lucrative real estate market. Whether they want the steady income and appreciation of a rental property, or a quick fix and flip, it’s easy to see why real estate is such an attractive investment vehicle to save for retirement. However, making the decision to purchase an investment property can become difficult if there are not enough funds in your IRA to purchase the property outright.

The most common solution to this problem is typically to obtain a bank loan; however, it’s not that simple when IRA funds are involved. Since the IRS does not allow the IRA owner to personally guarantee a loan, the only option in this situation is to obtain what’s known as a “non-recourse” loan.

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This type of loan is only offered by a small number of banks and essentially means that while the bank can foreclose on the property in the event of loan default, it cannot come after the IRA or the IRA owner if the borrower defaults. As a result, the interest rates are slightly higher due to more risk involved, as well as the IRA may be subject to UDFI tax, or “Unrelated Debt Financed Income” tax.

The purpose of UDFI tax is the IRS saying that only the percentage of income that was attributed to retirement funds should stay in a tax-advantaged status (tax-deferred for traditional IRA, or tax-free for a Roth IRA).

Real Estate

For example, the IRA has enough to purchase 60% of the property and the other 40% of the purchase price was leveraged by a non-recourse loan; only 60% of the income generated will stay tax-advantaged, the other 40% can be subject to UDFI tax. We won’t get into the complex calculations of UDFI tax for this article, but you should consult a CPA or ERISA attorney if you are thinking about a non-recourse loan and want to explore it further.

While UDFI tax and the slightly higher interest rate of a non-recourse loan is certainly not ideal, it’s at least an option, but what about other options? During these conversations it’s also clever to mention how you are using your IRA, as many individuals aren’t even aware that they can use their retirement accounts for real estate investments, so you may trigger a light bulb to go off in their head and they may also want to bring in retirement funds to complete the investment purchase.

Whether the other investors end up using personal or retirement funds, Provident Trust Group is happy to facilitate the investment transaction and act as custodian throughout the process. Hopefully this article has cleared up any questions you may be having about the process and potential pitfalls involved in real estate investing using retirement funds. We understand every situation is unique and that’s why we are here to guide our clients through this venture.

Please Note: Provident Trust Group and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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