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What a self-directed IRA is

A self-directed IRA is a traditional or Roth IRA held by a custodian that permits "alternative" assets, such as real estate, private company interests, and promissory notes secured by real estate. The tax rules are the same as any other IRA. What's different is the range of investments the custodian allows.

Most IRAs at large brokerage firms can only hold publicly traded stocks, bonds and funds. To hold a private real estate note, your IRA generally needs to be with a self-directed IRA custodian that accepts that type of asset. Whether a particular note is eligible depends on the custodian's policies.

How your IRA makes a private loan

1. Open a self-directed IRA with a custodian that permits private real estate notes.
2. Fund it by transferring an existing IRA or rolling over an eligible retirement plan, such as a former employer's 401(k). A direct trustee-to-trustee transfer avoids withholding and the 60-day rollover rules.
3. Review a specific opportunity with us and with your own advisors.
4. Sign the custodian's direction of investment, instructing your custodian to fund the loan or note purchase.
5. The custodian funds the investment through closing, and the note and recorded lien are titled in the IRA's name.
6. Payments flow back into your IRA, where they can be reinvested or distributed under the normal IRA rules.

Potential tax advantages

Interest earned outside a retirement account is generally taxed as ordinary income each year. Inside an IRA, that changes:

• Traditional IRA: interest income generally grows tax-deferred, and is taxed when you take distributions.
• Roth IRA: interest income can grow tax-free, and qualified distributions are generally tax-free.

Straightforward interest from lending is generally not subject to unrelated business income tax inside an IRA, but certain structures can change that. Tax treatment depends on your circumstances. Please review any investment with your CPA or tax advisor; we don't provide tax advice.

Prohibited transactions and disqualified persons

The IRS bars an IRA from transacting with certain "disqualified persons." Breaking these rules can cause the entire IRA to be treated as distributed, with taxes and possibly penalties. Among other things, your IRA generally can't:

• Lend money to you, your spouse, your parents or grandparents, your children or grandchildren, or their spouses.
• Lend to a business you (or those family members) control, or to certain advisors and fiduciaries of the IRA.
• Make a loan that you personally guarantee, or that benefits you personally outside the IRA.
• Mix personal money and IRA money in the same investment without careful planning, or have you pay the IRA's expenses personally.

Your custodian doesn't judge whether a transaction is prohibited; that responsibility is yours. We encourage every IRA investor to confirm with their custodian and tax advisor that a proposed loan is permissible before funding.

Custodian fees, liquidity and required distributions

• Custodian fees. Self-directed custodians usually charge setup fees, annual account fees, and per-transaction fees for funding investments and processing payments. These come out of the IRA and reduce your net return.
• Liquidity. A private note can't be sold like a stock. Plan for IRA money in a note to stay committed for the full loan term.
• Required minimum distributions. Traditional IRAs generally require annual distributions starting at age 73 (75 for people born in 1960 or later). If much of your IRA is in illiquid notes, you'll need enough cash elsewhere in the IRA to cover them, or plan for an in-kind distribution.
• Valuation. Custodians typically require an annual fair market value for each private asset.

IRA investments aren't automatically protected from loss

Holding a note inside an IRA changes its tax treatment, not its risk. A private note in an IRA isn't FDIC-insured or guaranteed, and self-directed custodians generally don't evaluate or endorse the investments their clients choose. The same property, borrower and default risks described on our Collateral & Risk page apply in full.

Common questions