Generally yes. A Roth IRA can hold a note when it is set up as a self-directed account with a custodian that accepts notes. The buying process is the same as for a traditional IRA. What differs is how the money is taxed going in and coming out, and that is a question for your CPA.
The steps of buying notes with an IRA are the same for either kind of account, so this page keeps to what a Roth changes.
What makes a Roth different
In broad terms, money can go into a traditional IRA before income tax and is taxed when it is withdrawn. Money goes into a Roth IRA after income tax, and withdrawals that meet the conditions for a qualified distribution are generally not taxed. Those conditions relate to your age and to how long the account has been open, and there are income-based limits on who can contribute directly. The details change, so check the current rules with a CPA or your custodian.
The type of IRA decides the tax treatment and has no bearing on what the account can own. That part is decided by the custodian’s list of assets it will hold.
Traditional and Roth compared for a note buyer
| Traditional self-directed IRA | Roth self-directed IRA | |
|---|---|---|
| Can it hold a note? | Yes, if the custodian allows it | Yes, if the custodian allows it |
| Who owns the note? | The IRA, through the custodian | The IRA, through the custodian |
| Where payments go | Into the IRA | Into the IRA |
| Tax on note income while it stays in the account | Generally deferred | Generally none |
| Tax on withdrawals | Generally taxed as income | Generally not taxed if the distribution is qualified |
| Rules on dealing with yourself and family | Apply | Apply in the same way |
A general summary only, not tax advice. Exceptions exist in every row. Confirm how the rules apply to you with a CPA.
Why some buyers choose the Roth for notes
A note produces interest income month after month. In an ordinary taxable account that interest is generally taxed each year. Inside a Roth the income builds within the account, and qualified withdrawals later are generally free of tax, which appeals to someone who expects to hold notes for many years.
Whether that appeal turns into a real benefit depends on your tax position now and later, so treat it as a reason to ask a CPA and no more than that. A Roth also does nothing to make a weak note stronger, and no tax treatment brings back money lost in a default.
What stays the same
The account still has to be self-directed, since a Roth at a brokerage firm is set up to hold that firm’s own products, and the account side of buying notes in a self-directed IRA applies without change. The IRA is still the buyer: the custodian signs for the account, and the note and the lien go into the custodian’s name for the benefit of your Roth IRA. Payments go to the account and expenses come out of it, with nothing passing through your own hands.
The prohibited transaction rules apply to a Roth as they do to any IRA. In general the account cannot buy from, sell to or lend to you or people closely connected to you, so get advice before any deal that involves family or a business you own.
What to raise with your CPA and custodian
- Am I eligible to contribute to a Roth, and what are my options if I am not?
- If I move money from another retirement account into a Roth, what tax does that create and when?
- Will the account hold enough cash after the purchase to cover legal fees or property taxes in a default? Contributions are limited, so a small account cannot easily be topped up.
- If the account borrows to buy a note, does any tax apply to the income?
- What will the custodian charge for holding a note and processing its payments?
Take the list to the CPA first, because the answers to the first two questions decide how much the account will have to spend. Ask as well how income from notes is taxed outside a retirement account, so that you are comparing the Roth with a real alternative.
Once the account is funded
A Roth buyer checks a note exactly as any other buyer does, with the same steps as the rest of the investor guide. Mention the Roth and the custodian when you join the buyer list, since a custodian’s processing adds time that a seller should hear about early. Then confirm that the money in the account is settled and available, because the custodian can pay only with what the Roth already holds.
Related questions
Is note income in a Roth IRA tax-free?
Income generally builds inside a Roth without current tax, and qualified distributions are generally not taxed. There are conditions and exceptions, including for income from assets bought with borrowed money. Confirm your position with a CPA.
Can I convert a traditional IRA that holds a note into a Roth?
Conversions are possible in general, and a conversion can create taxable income based on the value of what is converted. Valuing a note for that purpose takes care. Speak to a CPA and your custodian before you start.