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Buying Notes in an IRA and UBIT Ramifications

Is it a good idea to buy a real estate note in your IRA?

In my opinion, a note investment can be perfect for your IRA account. In many cases, the note that you buy may have several years of payments remaining on it. With an IRA, you cannot take money out of the account without early withdrawal penalties until you are age 59 ½. This allows you to buy longer-term notes in your IRA without having to worry how it will affect your personal finances.

The availability of cash in an IRA is also a benefit to buying notes in your retirement account. Let’s say you find a great deal on a note that you can buy for $75k, but you don’t have that much personal cash to make the investment. If you have had a 401k or an IRA for a number of years then it’s very likely that you have more than enough money to make that type of investment. If your money is tied up in stocks or mutual funds you would simply need to liquidate enough securities to make the investment.

One reason you would NOT want to buy a note in your IRA is if the person you are looking to buy the note from is a disqualified party to your IRA. It is a prohibited transaction to do business through your IRA with any disqualified party. A simple definition of a disqualified party is yourself, your spouse and any lineal family members.

UBIT and a Word of Caution

You may use non-recourse loans in your IRA to purchase notes. However, keep in mind that in a ROTH IRA any part of the investment purchased with borrowed money is subject to UBIT (unrelated business income tax). Since a ROTH IRA is funded with after-tax dollars, the UBIT fee allows the IRS a way to collect taxes on the income generated. By borrowing money in a ROTH IRA you avoid paying the upfront taxes that you would have paid if the money had been contributed instead of borrowed. The IRS understands this loophole and that’s why UBIT is charged on loans in a ROTH.

Terry White

About Terry White

I started my business career after getting my degree in Accounting from the University of New Mexico in 1983. My first job was as a controller for a local title company, and in 1987 I started First Financial Escrow, Inc. Over the years I played a part in several startup companies including First Financial Equities, Inc., First Financial Trust, Inc., First Financial Marketing, Inc. and Asset Ventures, Inc. In 1997 First Financial Escrow, Inc. was able to purchase the escrow accounts from Sunwest Bank and changed its name to Sunwest Escrow. As the market changes, Sunwest has grown and changed along with it. Besides my wife, Sheila, we have three boys, two daughters-in-law, one grandson, another grandson on the way and a future daughter-in-law. Sunwest is my passion, and I enjoy coming to work every day to see what will happen next. I enjoy fly fishing, spending time in Colorado, biking and watching my boys play soccer.