Are you one of those Investors that asks a lot of questions in a quest to learn more? Are you also one of those Investors that accepts information, but always looks to validate and verify what you’re told? Well, then this content is meant for you.
Recently we were engaged with a Borrower that was on a relentless pursuit to understand why their SDIRA (Self-Direct Individual Retirement Account) could only take a Non-Recourse loan. While we supplied a basic answer, it spurred us to dig deeper to answer the question: Why must a loan to my SDIRA be Non-Recourse? We wanted to have a more pointed, definitive answer, so we did some on-line research and here is what we came up with:
Internal Revenue Code Section 4975 prohibits an IRA holder from personally guaranteeing a Self-Directed IRA Loan. Pursuant to Internal Revenue Code Section 4975(c)(1)(B), a disqualified person (i.e. the IRA holder) cannot lend money or use any other extension of credit with respect to an IRA.
In other words, the IRA holder cannot personally guarantee a loan made to his or her IRA. As a result, in the case of a Self-Directed IRA, one could not use a standard loan or mortgage loan as part of an IRA transaction since that would trigger a prohibited transaction pursuant to Code Section 4975. This type of loan is often referred to as a recourse loan since the bank can seek recourse or payback from the individual guaranteeing the loan.
These loans are generally the most common types of loans offered by banks and financial institutions. Thus, in the case of a Self-Directed IRA, a recourse loan cannot be used. This leaves the Self-Directed IRA investor with only one financing option – a non-recourse loan. A non-recourse loan is a loan that is not guaranteed by anyone. In essence, the lender is securing the loan by the underlying asset or property that the loan will be used for. Therefore, if the borrower is unable to repay the loan, the lender’s only recourse is against the underlying asset (i.e. the real estate) not the individual – hence the term non-recourse.
Hopefully the above content provides better detail and clarity to answer this question. Of course, we are not tax professionals or investment consultants, so would always ask our Readers to confirm their understanding with those Professionals.