The hesitance is not unfounded, as it’s true that using loan to finance real estate investment for an IRA account is not permitted. And even Solo 401k rules have set out an entire section on prohibited transactions, which could lead to tax charges, penalties and even disqualification of the plan. (To learn more about prohibited transactions and how to avoid unnecessary charges and penalties, please read this page.)
Using non-recourse loan to finance real estate investments
With that said, financing real estate purchases with a loan is not impossible with a Solo 401k account. Account holders are allowed to use non-recourse loans to finance their purchases.
As Solo 401k rules stated, an account holder is prohibited from involving in giving a loan or other extension of credit to the plan, whether directly or indirectly. This rule makes it impossible for a plan to take out a recourse loan, since the plan does not have any credit history. The plan holder will need to act as a guarantor and by doing that, will take part in the loan process.
A non-recourse loan, however, will be given out with a collateral, which is the property itself. This means the Solo 401k plan can now borrow money from a creditor without any credit history or guarantor. In case of default, the creditor can only go after the property to recover the loan amount. Neither the plan holder nor the plan itself can be liable for the debt. For that reason, the plan holder is entirely not involved in the process.
No UBIT tax when using non-recourse financing for Solo 401k
Please note that while a self directed IRA is allowed to invest in real estate, it is not allowed to use non-recourse financing to invest in real estate. Doing so will trigger the Unrelated Business Income Tax (UBIT).
UBIT, on the other hand, is not applicable to Solo 401k rules. Therefore, the self employed retirement plan offers the flexibility to finance real estate investments as long as it is done via non-recourse loans. This is a great advantage for real estate investors, as now they are allowed all the tools they need to take their retirement investment to the next level.