Commercial Loans Blog

Commercial Loans, Bad Boy Acts, and Carve-Outs

Posted by George Blackburne on Tue, Mar 5, 2013

Yesterday I wrote a blog article explaining that if you buy a commercial property with your IRA, and you get a commercial mortgage loan from the bank to help you finance the purchase, you need to get the bank to make you a non-recourse loan (good luck with that).  If you don't, your IRA investment constitutes a prohibited transaction.

A non-recourse loan is one where the bank cannot come back after you personally for a deficiency judgment if they foreclose and take a loss.

I pointed out in my article yesterday that few banks will make non-recourse loans these days.  Fortunately Blackburne & Sons would be happy to make a non-recourse commercial real estate loan to your IRA.

Okay, but then a question came up.  What about a carve-out clause?  A carve-out clause is a provision in a non-recourse loan that says if a borrower commits certain Bad Boy Acts that the commercial loan suddenly becomes a full-recourse loan.

So what is a Bad Boy Act?  Bad Boy Acts include the following "bad-boy" behaviors:

(i) fraud or intentional misrepresentation by the borrower (you lie to the lender to get the loan in the first place); (ii) waste occurring to or on the mortgaged property (you take a sledgehammer to the property right before you lose it in foreclosure); (iii) gross negligence or criminal acts of the borrower that result in the forfeiture, seizure or loss of any portion of the mortgaged property (you set up a meth lab in the property and the government seizes the property); (iv) misapplication or misappropriation of rents, insurance proceeds or condemnation awards received by the borrower after the occurrence and during the continuance of an event of default (you steal the insurance proceeds check); and (v) any sale, conveyance, mortgage, grant, bargain, encumbrance, pledge, assignment or transfer of the mortgaged property, or any part thereof, without the prior written consent of the lender (you put a second mortgage on the property even though the loan documents specifically forbid it).

So here's the question?  Can a non-recourse loan to an IRA have a carve-out provision?  The answer is that no one knows for sure.  The IRS has yet to litigate it.  My personal opinion is that the IRS would probably NOT declare a non-recourse mortgage loan to be a prohibited transaction simply because it contains a few standard carve-outs.

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Topics: Bad Boy Acts