Personal note and SD IRA note on same project.

11 Replies

My wife and I have written a personal note (made a loan) on a real estate project. This project is going to require more funding to complete. I am considering providing a second loan, from my self-directed IRA (or my wife's Solo 401K), to this project. The SD IRA loan will be in second position. Would this be considered a prohibited transaction?

Sounds prohibited. If you already have an ownership stake in a real estate project you cannot invest/lend/supply IRA funds to it. On top of that, if retirement money is involved you cannot guarantee a loan.

The following are some common examples of prohibited transactions. The self-directed IRA or Solo 401k accountholder may not:

  • Sell a property that he/ she owns personally to the Solo 401k or self-directed IRA
  • Personally guarantee a loan for a real estate purchase by the Solo 401k or self-directed IRA

We do not have an ownership stake in the project. We are not on title. We have made a loan to the investor secured by a mortgage on the property. We are considering making a second loan on the same project from the IRA.

@Jeff Rabinowitz  

From what you've written, I would think this would be acceptable. I know individuals 'partner' with SDIRA on deeded interest for ROTH and traditional IRA investments. Here's how one deed is written in my county in NC:

EQUITY TRUST CO CUSTODIAN FBO PARTY A IRA with 11.7% undivided interest and
EQUITY TRUST CO CUSTODIAN FBO PARTY A IRA with 12.46% undivided interest and
PARTY A individually with 25.84.7% undivided interest and
PARTY B with 50% undivided interest

I assume one of the two IRAs is a ROTH, but the above (save for the names removed) is what is written in the Grantee field of the GWD. Your Deed of Trust (mortgage) which would fit your scenario would be in second position, which is fine if that's your investment decision. ETC and other custodians don't really care about the lien position, as long as you are not owner of the property.

You're fine, you can make a second, the borrower can guarantee it. Now, if there is a default on one or both, foreclose on the second, that way you won't be paying off the second with what could be comingled funds from the sale of proceeds. Your retirement fund must act independently from you without you having any beneficial interest in the use of funds.

BTW, the maker of a loan/note is the borrower, the lender creates or provides the note and is the note holder.  The borrower made the note obligation and is the "maker". :)

Edited:

Chris, that may have been done, but I'd not as there could be a beneficial interest as an affiliate or co-lender, you can't make the loan without the lenders joining in and thereby giving the opportunity to benefit from the interest, it's too close for me.

A partitioned note as to Principal Part A being owned by ABC and Principal Part B being owned by DEF and Principal Part C being owned by SoandSo, with lien priorities in order of A, B, C would be cleaner, even better, make an entirely different loan not comingled at all. :) 

This sounds like a prohibited transaction to me.  

You are not supposed to backstop or otherwise support your IRA's investment activities with personal funds or guarantees.

Suppose that a project needed 100K and a year to complete, and the going rate was 8%. Someone dual lending could make a personal loan of $90K at 1% ($900) and an IRA loan of $10K at 71% ($7,100). Borrower pays same rates in the single loan and split loan scenarios. Lender could bury his profits in the non-taxable account. IRS doesn't like this.

For this reason, I think you are on very shaky ground.  

Also, in the event you had to foreclose, you would be supporting a property you owned with your IRA's debt, or a property your IRA owned with your debt. Both of these are prohibited.

I would check with your custodian and err on the side of caution.  Make another personal loan if you need to get the project done.  

Or don't be sad if you roll the dice and you get hit with a tax penalty if it goes south on you.  

Good luck.   

You will want to talk to your CPA for a professional opinion that carries any weight. My CPA would feel this is a prohibited transaction and I think most would agree. There are some IRA custodians who would allow you to use funds out of your IRA with a separate note from your personal funds. I suspect they also require you to sign a waiver you are responsible for all consequences of your transaction and nothing they do or say qualifies as legal advise.

Originally posted by @Tom V.:

This sounds like a prohibited transaction to me.  

You are not supposed to backstop or otherwise support your IRA's investment activities with personal funds or guarantees.

Suppose that a project needed 100K and a year to complete, and the going rate was 8%. Someone dual lending could make a personal loan of $90K at 1% ($900) and an IRA loan of $10K at 71% ($7,100). Borrower pays same rates in the single loan and split loan scenarios. Lender could bury his profits in the non-taxable account. IRS doesn't like this. ............

Also, in the event you had to foreclose, you would be supporting a property you owned with your IRA's debt, or a property your IRA owned with your debt. Both of these are prohibited.

Agree, the "dual lending" doing a participation loan between yourself and your IRA, which is what I was saying, however, you can't do the accounting or split rates with your IRA, besides 71% has other issues, why such a spread between your IRA and you individually, justify that. You're speaking of fraud, not just comingling of funds, such an intentional act would need to be supported.

as to foreclosure, that's why I said have the second (IRA) take the lead on the foreclosure, there is no "backstop" the trustee at the sale pays the first lien from sale proceeds, then the second, there is no comingling there and the individual never touches the funds. The IRA note is subordinate.

In a Partitioned Note one part can be subordinate to another, the accounting must be correct as the audit trail for disbursements, I would add the note needs to be serviced.

A loan made from a retirement account should never have cash proceeds or payments pass through the beneficiary of the account, it should be going to the administrator of the trust.

Again, separate notes are cleaner, make sure the first never provides any benefit to the second which is the normal course of business.

Depending on your account, you can also draw funds out and use them any way you like, you just need to replace those funds within the time requirement to avoid penalties, if it's a short term to the end of the project, you might accomplish the goal this way just making an advance under the existing loan as a modification or just make a new note. :) 

@Tom V. , I agree that the scenario you describe might raise attention. I am not proposing anything of the kind. The rate on the existing note would be the same as the rate on the proposed note from the IRA. Two separate loans that are secured by the same collateral which is worth considerably more than the combined total of the notes.

Jeff - I understand that is not your intent.  I still think you are proposing a prohibited transaction.  

 At the end of the day, my opinion or anyone else's here is irrelevant. 

There is an IRS office at 500 Woodward in Detroit.  You can walk in there and get a real answer for free, at least one that is a lot more reliable than a bunch of 'informed guesses' like the ones I and others have put forth.  :)  I recommend going in person instead of calling as if you get face-to-face with someone they will treat you more decently and you will better be able to explain yourself and your situation.  

Let us know how it works out - I would love to create a stacked financing with my own personal taxable funds taking the senior low return position and my IRA taking the junior high return position. I just don't think it flies...

Good luck!

Originally posted by @Jeff Rabinowitz:

@Tom V. , I agree that the scenario you describe might raise attention. I am not proposing anything of the kind. The rate on the existing note would be the same as the rate on the proposed note from the IRA. Two separate loans that are secured by the same collateral which is worth considerably more than the combined total of the notes.

I have inquired with my SDIRA custodian on this previously and was told that it would be a prohibited transaction even if the two notes had identical rates, terms, etc.  The way it was explained to me was that without the SDIRA funds I wouldn't have been able to fund the transaction, therefore I benefited personally from the SDIRA funds and my SDIRA benefited due to my personal funds.

"When you invest together with your IRA you run the risk of committing what is called a Prohibited Transaction. The Internal Revenue Code 4975 details these.

If you receive "personal benefit" because of your IRA investment then it is prohibited"

Scott Williams

I'm certainly no expert, but this sounds like a prohibited transaction to me.

General rule of thumb is that you can't do anything to benefit your IRA funds and your IRA funds can't do anything to benefit you personally. The fact that you're using IRA funds to "bail out" the project (it doesn't have the funding required to move forward to completion), your IRA funds are benefiting you personally.

But again, I'm not a tax/ERISA professional, so take that for what it's worth...

EDIT:  Looks like Scott beat me to it above...sorry for the repeated info...

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