Use our new AI tool to find the right Self-Directed IRA!

IRA Financial Blog

What is a Non-Recourse Loan and How does it Work?

What is a Non-Recourse Loan and How does it Work?

Since the creation of IRAs in 1974, real estate has become a popular investment category for millions of retirement account investors.  Many IRA or 401(k) investors will use their retirement funds to purchase real estate directly with account funds.  However, with real estate prices rising over the last several years, more investors have looked to borrowing funds to buy properties. What is a non-recourse loan and how does it affect retirement account investments?

Key Points
  • When borrowing funds to make a retirement account investment, the loan must be non-recourse
  • A Self-Directed IRA or Solo 401(k) can be used to make alternative asset investments
  • When using an IRA to finance a property, be aware of the UBTI tax

Recourse & Non-Recourse Real Estate Loans

What is a Recourse Loan?

The most common type of real estate loan is a recourse loan.  It is a loan personally guaranteed by the borrower.  Almost all residential mortgages are recourse loans.  Having a recourse loan means that if there is a default, the lender can attempt to cure it by not only seizing the underlying real estate but also pursuing the individual borrower personally.  The recourse mortgage is what caused many borrowers to declare bankruptcy in the 2008 financial crisis because the equity they had in the real estate investment collapsed which forced the lenders to pursue the individual borrowers personally.  Today, most residential, and commercial mortgages are still recourse.

The IRS and Retirement Account Recourse Loans

Internal Revenue Code (IRC) Section 4975 prohibits the IRA owner from personally guaranteeing a retirement account loan. Specifically, 4975(c)(1)(B) holds that a disqualified person cannot lend money or use any other extension of credit with respect to a retirement account.

As a result, in the case of a Self-Directed IRA, one could not use a standard loan, such as a mortgage, as part of an IRA transaction since that would trigger a prohibited transaction. This leaves the Self-Directed IRA investor with only one financing option – a non-recourse loan.

Related: Self-Directed IRA for Real Estate

What is a Non-Recourse Loan?

A non-recourse loan is a loan that is not guaranteed by the borrower. The lender is securing the loan by the underlying asset or real estate that the loan will be used for. Hence, if the borrower is unable to repay the loan, the lender’s only remedy is against the underlying asset and not the borrower personally.

Below are some common characteristics of a non-recourse loan:

  • The loan cannot be personally guaranteed by the borrower.  Verify loan documents that this is the case.
  • Most non-recourse lenders will require at least 30% equity down; others will want at least 40%.
  • Expect to pay a higher interest rate for a non-recourse loan since the lender is taking more risk.
  • Many lenders will not do a non-recourse loan associated with a real estate project in certain states (such as New York and Vermont) that have very pro-tenant rules, which make foreclosure difficult.
  • Do your diligence on the nonrecourse lender and don’t be afraid to shop your deal around. (For Self-Directed IRA and Solo 401(k) real estate investors, IRA Financial has a number of non-recourse lenders that our clients work with.)

In general, a non-recourse loan is far more difficult to secure than a traditional recourse loan or mortgage.

Tax Treatment of Using a Non-Recourse Loan

Most investments made with a retirement plan will be tax-deferred (or tax-free in the case of a Roth account).  However, the use of a non-recourse loan in connection with an IRA or 401(k) investment could trigger a tax known as UBTI, Unrelated Business Taxable Income.

In general, if non-recourse debt financing is used, the portion of the income or gains generated by the debt-financed asset will be subject to the UBTI tax. For example, if an individual invests 80% IRA funds and borrows 20% using a nonrecourse loan, 20% of the income or gains generated by the investment would be subject to the UBTI tax.

As stated earlier, the IRS allows IRA and 401(k) plans to use non-recourse financing only. The rules covering the use of non-recourse financing by an IRA can be found in IRC Section 514 which requires debt-financed income to be included as unrelated business taxable income, which generally triggers a maximum tax of 37% tax in 2023.

401(k) Exception

When one uses non-recourse financing to invest in real estate with a 401(k), there is no UBTI tax, pursuant to IRC Section 514(c)(9). To take advantage of this exception, generally, you need to be self-employed to be eligible for a Solo 401(k) plan. The reason for this is that most traditional 401(k) providers do not allow for alternative investments. A Solo 401(k) allows you the freedom to invest in just about anything you want, including real estate.

Get Started

Please enable JavaScript in your browser to complete this form.
Step 1 of 4

Choose your Self-Directed retirement account


An investor looking to invest in real estate with retirement funds who also wishes to use leverage to purchase the property, or another asset may only use a non-recourse loan.  The procedures for acquiring a non-recourse loan are essentially the same as a mortgage.  However, since the borrower is not personally guaranteeing the loan, the lender will require more cash down and will generally charge a higher interest rate.

It’s up to you as the investor to weigh the pros and cons when using leverage to make a real estate investment. The more retirement funds you use, the less tax you will owe from the income generated by the financed investment. Alternatively, if you are self-employed, you can completely avoid the UBTI tax.


Latest Content

Send Us a Message!