Non-Participant Loan for Property Purchase

[katdmin]

Hello, a colleague asked me a question and I just don't know the answer. 

Client wants to purchase real estate in the plan but they don't have enough of a cash balance in their account.  They are asking if they can take out a bank loan to purchase the RE (apparently, he wants to use current property in the plan as collateral to borrow the money.). 

We both don't believe it's possible (PT?) - the plan would be basically taking out a loan?    

 

Thank you!

[shERPA]

Plans can borrow to purchase real estate assuming the trust language in the document authorizes it (typically it does).  This could create UBTI unless the loan meets the acquisition indebtedness exeception in IRC 514 (I forget the subsection at the moment).

But good luck getting a conventional lender to loan to a plan.  Lenders can't qualify plans using standard metrics, and they pretty much all want to use standard metrics so their loans can be sold.  They will make suggestions such as telling the client to buy the property personally and then quit claim it to the plan after the financing is in place, or that they want the client to guarantee the loan.  These sorts of lender workarounds typically create PTs. 

[katdmin]

Thanks so much!  This is definitely not my expertise!  

[JOH]

Plans can take out loan but it has to be a non-recourse loan. They can't use anything as collateral and the loan must be made strictly on the merits of the property (e.g. you can't look at credit score or income of the participant). And assuming income is generated from the property, there will be UDFI (a segment of UBIT) owed by the plan. There are some banks that specifically do non-recourse loans

[Luke Bailey]

On 2/10/2021 at 3:11 PM, shERPA said:

IRC 514 (I forget the subsection at the moment)

514(c)(9).

[Luke Bailey]

2 hours ago, JOH said:

has to be a non-recourse loan

Presumably this is a self-directed plan. I think the loan could be recourse against the account and other assets of the account could be pledged. But completely agree that usually completely impractical. Some lenders that specialize in this will do for IRAs, but with a qualified plan with multiple participants, even self-directed, the paperwork would be novel and complicated, scaring off most lenders, if not the plan sponsor.