Generally yes, if the account is a self-directed IRA held with a custodian that allows notes. The IRA buys and owns the note in place of you personally, and the rules about who the account can deal with are strict. Speak to a custodian and a CPA before you commit to a purchase.
Why an ordinary IRA will not do it
An IRA at a brokerage firm or a bank is set up to hold what that firm sells: stocks, bonds, funds and deposits. The limit comes from the firm’s own menu. A self-directed IRA is an IRA held with a custodian or administrator that permits a wider range of assets, which can include privately held notes secured by real estate.
The custodian holds the asset and keeps the records. Evaluating the note, and avoiding a bad purchase, stays with you.
How a purchase works inside an IRA
- Open and fund the account. Money moves in by a transfer or rollover from an existing retirement account, or by a contribution. Your custodian will tell you which routes are open to you.
- Find and check the note. The due diligence in the investor guide applies to an IRA exactly as it does to any other buyer.
- Direct the custodian to buy. You complete the custodian’s instruction form, and the custodian signs the purchase documents on behalf of the IRA.
- Title goes to the IRA. The note is endorsed and the mortgage or deed of trust is assigned to the custodian for the benefit of your IRA, in the wording the custodian requires. Your own name does not go on it.
- Payments go back to the account. The borrower’s payments are sent to the IRA, by a servicer if you use one, and never pass through your personal bank account.
- Costs come from the account. Servicing fees, legal fees and any taxes or insurance advanced on the loan are paid from IRA funds.
The rules that catch people out
Retirement accounts get their tax treatment on the condition that the account is not used for your personal benefit today. The rules that enforce this are known as the prohibited transaction rules. In general terms, your IRA cannot deal with you or with certain people and entities closely connected to you, called disqualified persons, a group that commonly includes close family members.
That points to questions such as these:
- Is the note being bought from you, from a relative, or from a company you control?
- Is the borrower on the note you or someone closely related to you?
- Would you be paying an IRA expense from your own pocket, or taking an IRA payment into your own account?
If the answer to any of them might be yes, stop and get advice, because a prohibited transaction can have severe consequences for the whole account. Your custodian can tell you what it will and will not process, and a CPA or tax attorney can tell you whether a specific deal is allowed.
Cash, fees and debt inside the account
Leave cash in the account after the purchase. If the borrower defaults, the IRA has to pay the attorney and any property taxes, and you cannot top it up from personal funds at will, because contributions are limited by rules your custodian or CPA can explain. Self-directed custodians charge for the account and may charge for each transaction, which takes a noticeable share of the income from a small note, so compare fee schedules as part of buying notes in a self-directed IRA.
Borrowing changes the tax picture. If an IRA borrows money to buy an asset, a tax can apply to part of the income even though the account is an IRA, so ask a CPA before using any debt. A note is also hard to sell quickly, so an account that will soon be paying money out to you needs cash to cover it.
A note in an IRA carries every risk a note carries anywhere else, with extra rules on top, and nothing on this page is tax or investment advice. The same steps apply if you buy notes in a Roth IRA, where only the tax treatment differs.
Call the custodian before you look at notes
Ask the custodian whether it holds real estate notes, how it wants the note and the assignment worded, how long it takes to process a purchase instruction, and what it charges. Those answers shape which notes you can realistically bid on. Then, when you join the buyer list, say that you will be buying through an IRA and name the custodian, so the seller hears about the extra paperwork step at the start.
Related questions
Can I move a note I already own into my IRA?
Selling your own asset to your IRA is the kind of dealing the prohibited transaction rules are aimed at. Do not attempt it without advice from a CPA or tax attorney and a clear answer from your custodian.
Does the custodian check the note for me?
No. A self-directed custodian holds the asset and processes the paperwork you direct. It does not review the quality of the note or the title. Due diligence remains your responsibility.
Can I use a 401(k) or other retirement plan instead?
Some plans can be rolled into a self-directed IRA, and some self-directed plan types exist for the self-employed. What is open to you depends on the plan and your circumstances, so ask the plan administrator and a CPA.