The unlimited investment capability of the Solo 401k Plan allow account funds to be invested into non-traditional assets, such as real estate. Account owners who choose to purchase real estate can leverage the purchase with a non-recourse loan. A recourse loan cannot be used with a Solo 401k to make investments; it would be considered a prohibited transaction.
A recourse loan is the most common type of loan offered by banks and other financial institutions. The recourse loan is guaranteed by the individual securing the loan. Investing with self directed Solo 401k and a recourse loan is considered a prohibited transaction because the account owner would have to guarantee the loan to the account. This is prohibited by IRC Section 4975.
In most cases, this can be avoided by the use of the Solo 401k to pay the full amount of the real estate investment. If additional funding is needed for the purchase, the IRS allows the use of non-recourse loan with the Solo 401k.
A non-recourse loan is not guaranteed by the individual. Instead, the non-recourse loan is secured by and limited to the collateral, in this case the real estate property itself. Because the loan does not involve the individual/ account owner, it is not considered a prohibited transaction by the IRS. In general, non-recourse loans are considered to be more risk to the lender and thus have less attractive terms than those of conventional recourse loans.
The rules for the use of non recourse financing by the Solo 401k are outlined in IRC Section 514. It’s important to note that the use of non-recourse loans with the 401k WILL NOT trigger the UBTI tax. The Solo 401k plan is exempt from the UDFI Tax rules on leveraged real estate, which is one of the reasons that this plan is more superior compared to Self Directed IRA. Because of an exclusion in the Unrelated Debt Financed Income rules, the Solo 401k is not subject to the UBTI tax when using non-recourse funding to invest in an asset.
For the list of lenders and to apply for non-recourse loan please visit our Non-Recourse Lenders list.
Eligibility and requirements
A non-recourse lender typically asks for a 30 to 35% down payment. Any account holder of a Solo 401k with at least 30 to 35% of the property price in the account can apply for a non-recourse loan. The application is then subject to an approval process, including an appraisal of the property.
There are also certain requirements for the property to be purchased with the non-recourse loan.
The financed property usually has to generate sufficient Net Operating Income (rents minus operating expenses) to exceed the debt payments by 20–25%.
Eligible Rental Properties: Account holders can apply for non-recourse financing to purchase a Single family detached residential, warrantable Condo’s, PUD’s, duplexes, 4-plexes, or a multifamily home (5 or more units).
Ineligible Properties: The following properties cannot be acquired with non-recourse financing: Residential with large acreage, raw land, farms, rural properties, manufactured or log homes, non-warrantable condos, Condo Hotels, Co-ops, Time Shares, hotels, senior or assisted living facilities, non-franchise restaurants, entertainment properties, ministorage, and commercial property.
The Non-recourse Loan Application process
After the full application is submitted, the loan approval process includes property appraisal and fund verification.
The lender will quote an interest rate, which is calculated based on the property type and down payment. Other fees and costs may apply and vary from one lender to another.
Documentation Required for Loan Approval:
- Completed loan application
- Current detailed Rent Roll or copies of signed leases. This is not required for currently unoccupied properties.
- Most recent asset statement verifying the Solo 401k funds for the property purchase and reserves.
- Purchase/Sales contract, signed by the account holder and the administrator. The contract must show the buyer to be in the name of the Solo 401k plan.
- Acceptable real estate appraisal for the property to be financed. Appraisal fee is required at the time of loan application.