Your IRA invests directly in real estate through the outright purchase with the deed in the name of the custodian. The absolute simplest transaction is an all cash purchase. The IRA needs enough cash to cover the purchase price, al closing costs, custodial fees and ongoing property expenses.

More typically the IRA obtains a non-recourse loan where the only recourse to the lender is the property. This usually requires a down payment of 30-35%, and reserves to handle mortgage payments and other property expenses in the event of insufficient rental income or property repairs.

When you borrower with your IRA

• You cannot guarantee the loan personally
• You cannot co-invest with your IRA
• You pay tax on any income or capital gains derived from leverage
• You increase the returns and growth of your IRA two to three times

About using Leverage

• UBIT (Unrelated Business Income Tax) IRA must’s pay UBIT on income/gains associated with the leverage percentage based on UDFI (Unrelated Debt Financed Income).
• UBIT is calculated using a 990T form.
• UBIT sounds complicated and expensive but it is not and is less than normal tax rates. The amount is determined by the relationship of the average amount of debt during the preceding 12 months to the property’s tax basis. This amount is taxed at a trust tax rate.
• Bottom line is to work with a professional early on in the transaction and look at the total return on the investment. If it is a good transaction and you would purchase outside of the IRA then the UBIT/UDFI will not be a factor in your decision.

A brief example should clarify the UBIT. Let’s say that your IRA bought a house priced at $100,000. The down payment was $50,000 and your IRA is in debt for $50,000. Let’s further assume that you have a tenant for the house and that after annual deductions for expenses etc. your IRA has a net income of $1,280. Since the first $1,000 is not subject to taxes, only $280 will be used in the UBIT calculation.

In this case the ratio of the debt is 50% of the tax basis of the property therefore $140 (50% of the taxable net income) is subject to the UBIT. This amount is taxed at the trust tax rate say 37.5% (The trust tax is a moving target as all tax rates and subject to change by congress). So in this example $140 x $37.50 = $52.50. Clearly as the debt is reduced, the UBIT decreases proportionately and disappears if the property debt is eliminated.