Private Lending in a Self-Directed IRA
Also sometimes called peer-to-peer lending, this strategy allows the IRA to play the part a bank normally would in extending private notes to individuals or entities seeking to borrow money. Private lending in a self-directed IRA allows you earn income on the interest and terms of loans on a tax-free or tax-deferred basis. All payments from the borrowers go into your IRA.
As the IRA owner, you call the shots. You vet the borrowers and set the terms of the loan—the interest rate, down payment, and repayment window. You also determine if the loan is secured or unsecured.
Secured loans typically use real estate as collateral for a private mortgage. However, the IRA can also use other assets like automobiles, private stock, and livestock as collateral. In case of default by the borrower, the IRA takes ownership of the property to recoup losses.
Unsecured loans have more risk and typically carry higher interest rates since they are not backed by collateral. In your IRA, this loan is in the form of a promissory note.
Advantages of private lending in an IRA
For the IRA owner: You choose the terms of the loan and earn tax-free or tax-deferred income in your IRA.
For the borrower: They receive cash faster than with a typical lending institution, and the requirements are less stringent than with banks or mortgage companies.
Tips for private loans in an IRA
You must understand the legal process for enforcing secured and unsecured loans. If personal property is used as collateral (i.e., a car or a collectible) the IRA may be unable to take possession of the asset.
Your IRA is prohibited from lending money to disqualified persons or entities, regardless of the terms. This includes loans which indirectly benefit a disqualified person.
States have different rules for private lending in a self-directed IRA. Consult appropriate counsel when investing this way.