Investing in Notes Through a Self-Directed IRA

Published on October 3, 2019

Private notes, also called promissory notes, may be mortgage notes or deeds of trust, private loans, or corporate debt, and are among the many alternative assets allowed in a self-directed IRA. “Promissory” indicates that there is a written promise to repay the sum according to the terms of the loan.

These notes comprise a form of private lending from the self-directed IRA, with the same tax advantages that the retirement plan allows. Investing in notes is not only popular, it’s a great way to help someone who needs funding and earn passive, tax-advantaged retirement income at the same time. It is important, however, to note that the borrower cannot be a disqualified person, as defined by IRS Publication 590.

Notes may be secured with collateral—like mortgages that have real estate to back up the loan; in fact, real estate notes represent a fast-growing segment of self-directed investments. With a secured loan, if the borrower does not pay back the loan, the lender gets the collateral in lieu of payment.

Promissory notes may also be unsecured (without collateral), which carries some risk because there is no recourse if the loan goes unpaid (other than taking a borrower to court).

Real estate notes—an attractive nontraditional investment

Here are four reasons why real estate notes are popular among self-directed investors.

• Even though the loan is backed by real estate, the owner of the self-directed retirement plan does not need to be involved with activities related to owning and caring for the property—that is the borrower’s responsibility or can be delegated to a third party. Instead, the self-directed IRA acts in effect like a bank, with funds loaned out to a third-party borrower (who must not be a disqualified person as stated above).
• The IRA generates interest income and the profits are tax-advantaged (either tax-deferred or tax-free, depending on the type of IRA).
• The investor does not have to take title to a piece of real estate in order to profit from the transaction.
• The self-directed IRA may be able to purchase an unpaid balance on a note at a discount.

As with any self-directed investment, the loan is made from the retirement account (not personal funds) and loan payments flow through the retirement account, with terms worked out by both parties. Similar to a bank loan, terms on a promissory note may include amount owed, interest and monthly payment amounts, and the loan’s maturity date.

Types of real estate notes

Just as there are many ways to invest in real estate directly through a self-directed IRA, there are different types of real estate notes (loan types) and scenarios, including:

• Performing vs. non-performing
• First position vs. second position liens
• Owner occupied vs. rental property
• Single family, multifamily, land, mobile, commercial

Do your research before investing in notes

Self-directed investors are those who are comfortable making their own investment decisions and conducting thorough research/due diligence before making any investment(s). From property liens, to real estate appraisals, to the borrower’s creditworthiness, there are many items to check off your list before entering into a transaction.

For investors who wish to include notes or private placements in their retirement plans, or if you’d like more information about self-directed IRAs, please register for a complimentary educational session with one of our representatives. Alternatively, you can email us at NewAccounts@NextGenerationTrust.com or call 1.888.857.8058.