A self-directed IRA can generally own a private note, provided the custodian allows it and the deal stays clear of the rules on self-dealing. The IRA is the buyer, the IRA holds the lien, and every payment and every expense passes through the IRA. Talk to the custodian and a CPA before you bid.
What follows is how the purchase works in practice and where people go wrong, at more length than the short answer to can I buy notes with my IRA? It is general information only. Retirement account rules are detailed, they change, and breaking them can be expensive, so take tax and legal advice on your own situation.
What “self-directed” means
An IRA is a tax-favored retirement account. A brokerage firm’s IRA is limited to what that firm offers, such as stocks, bonds and funds. A self-directed IRA is an ordinary IRA held with a custodian that also permits other assets, such as real estate and private loans. The tax rules are the same and the menu is wider.
You pick the investment and tell the custodian to make it. The custodian holds the asset and keeps the records. It does not check whether the note is a good one, so the due diligence stays with you.
How the purchase works
- Open and fund the account. By a transfer or rollover from another retirement account, or by a contribution. Your custodian will explain which routes are open to you.
- Find and price the note. Exactly as you would with your own money, using the pricing and due diligence in the guide for note investors.
- Sign the purchase agreement in the IRA’s name. The buyer is the account, and the custodian will have a required format for naming it.
- Send the custodian a written direction. This is the form telling them to buy this asset, for this price, from this seller. They will ask for the supporting documents.
- The custodian wires the funds. From the IRA’s cash to the closing agent.
- The note and the lien are assigned to the IRA. The custodian receives or records the documents according to its own procedure.
- Payments go to the IRA. The servicer, the company collecting the payments, pays the account directly.
Custodian processing takes time. Tell the seller or broker at the start that the buyer is an IRA, and build the custodian’s turnaround into the closing date. With us, the moment to say so is when you join the buyer list: name the custodian, and its process is allowed for in the timetable from the first file you see.
Getting the name right
Because the account owns the note, the documents name the account. The endorsement on the note and the assignment of the mortgage or deed of trust are made out to the custodian for the benefit of your IRA, in wording that each custodian sets for itself.
Get that wording from the custodian in writing and give it to the closing agent before documents are drafted. An assignment recorded in your personal name by mistake can look as though you personally received an asset that belonged to the account.
Some investors use an LLC owned by the IRA so they can sign and pay from a company bank account. This structure has its own costs and risks, and professional views on it differ, so ask an attorney who works with retirement accounts before you consider it.
The rules that catch people
The broad idea is that the account exists to fund your retirement, so you and people close to you may not benefit from its assets in the meantime. Deals that cross that line are called prohibited transactions. The exact definitions belong to your CPA or attorney. In general terms, expect trouble if:
- The IRA buys a note from you, or sells one to you.
- The payer on the note is you, your spouse, or a close family member such as a parent or a child, or a company one of you controls.
- You personally pay an expense that belongs to the IRA, or the IRA pays one of yours.
- You are paid for work you do on the IRA’s note.
- You personally promise repayment of a debt the IRA owes.
The consequences of a prohibited transaction can be severe, up to the account losing its tax-favored status. So before every step, ask who is on the other side of it and whether any of the money touches you.
Every dollar goes through the account
The IRA pays the purchase price, the closing costs, the servicing fee, any legal bill and the custodian’s own fees. The IRA receives every payment and any payoff. You do not cover a shortfall out of pocket, and you do not deposit a payment into your own bank account, even briefly.
The account therefore needs cash beyond the purchase price. If the payer stops and the note needs an attorney, the IRA has to be able to pay that attorney, and an account that put all its cash into one note cannot. Contribution rules may stop you adding money at the moment you need to.
If the payer defaults
The IRA is the lender, so the IRA enforces the loan. A workout agreement is signed by the custodian at your direction. A foreclosure is brought in the IRA’s name and paid for with the IRA’s money. If it ends with the IRA owning the property, the same rules follow the property: you cannot live in it, work on it yourself or pay its bills personally.
Tax, in outline
How the account is taxed depends on the type of IRA, and the differences are large. In a traditional IRA, tax is generally deferred until money is withdrawn. In a Roth IRA, qualified withdrawals are generally tax-free. Can I buy notes in a Roth IRA? looks at that case.
Raise two further points with your CPA. An IRA that borrows money to invest, or that runs something closer to a business than an investment, can owe tax of its own. And some account types require withdrawals once you reach a certain age. A note cannot be withdrawn in slices as easily as a fund can, so plan where that cash will come from. For income held outside a retirement account, see how income from notes is taxed.
Is a note a good fit for your IRA?
| A note fits better when | Think again when |
|---|---|
| The account can buy the note and still hold a cash reserve | The purchase would use nearly all of the account |
| You will not need the money for years | Required withdrawals are close |
| The seller and the payer are strangers to you | Family or your own business is involved in any way |
| You are content to let a servicer and the custodian handle every dollar | You expect to manage the note hands-on |
Calls to make before you bid with retirement money
Ring the custodian first. Ask whether they hold private notes, what documents they need to fund a purchase, how long funding takes, and the exact name the assignment should carry. Then put the specific deal, including who the seller and the payer are, in front of a CPA or attorney who knows retirement accounts.
With those answers in hand you can bid like any other buyer, apart from the longer closing. If either call leaves a doubt about who is on the other side of the deal, resolve it before you send the custodian a direction to fund.
Related questions
Can my regular brokerage IRA buy a private note?
Only if the firm holding it accepts private notes, and a brokerage firm's IRA is limited to the investments that firm offers. Otherwise you would need a custodian that accepts private notes, then move funds to it by transfer or rollover. Ask both firms how that works for your account type.
Can I add my own money if my IRA is short for a purchase?
Mixing personal money with IRA money in one purchase raises questions that need professional advice before you act. Some structures are used for it, and the rules are strict. Ask your custodian and a CPA before signing anything.
Does the custodian review the note for me?
No. A custodian holds the asset, processes the paperwork and keeps the account records. It does not judge the payer, the property or the price. You are responsible for the due diligence, as you would be with your own money.