How to structure a small short-term loan for SDIRA deal

Question

I plan to enter into a deal using my Roth IRA funds which are invested in an LLC with checkbook control. I have about $67k available. Including some cushion for contingencies the deal will probably require about $72k. Since I am the sole source of funding I would like to arrange a short-term private loan for the $5k. I expect this to be three to six months duration. I don't foresee any problem to find a non-prohibited person to provide the $5k. I'm just not sure how to structure the loan agreement. Would the other person be loaning directly to the LLC that my Roth owns? Can I deposit the funds into that account? I did look through other threads to find this info but didn't see anything that directly addresses this point of a small short-term loan.

Shera Gregory · Answer

Thanks @Mark Nolan! This is why I love BP. That's exactly the type of info I need. I understand that this is not legal advise, but information based on your experience with similar arrangements. Just what I was looking for.

Mark Nolan · Answer

@Shera Gregory

Here is how a non-recourse loan is generally drafted based on my experience.

1. The words "Non-Recourse" are listed on the note (generally at the top of the form)

2. The following is also listed: note amount, the date, and the address of the property being purchased.

3. The LLC is listed as the borrower along with the LLC's address.

4. The lender is listed along with their address.

5. The amount being borrowed is listed.

5. The following non-recourse language is listed:

The obligations of Borrower under this Note are NON-RECOURSE, and in the event of default by Borrower under the Note or other loan documents, lender will look solely to the collateral securing payment of this Note for repayment of the indebtedness owed by Borrower.

6. The note term, interest rate, security (the property being purchased) are all listed.

7. The following is also listed:

• a.This note shall be governed by and construed in accordance with the laws of the State of _____________.
• a.This note may not be amended or modified except by a written agreement signed by the Borrower and Lender.

8. Both parties sign the note: the IRA LLC manager and the lender.

Lastly, all note payments are made using IRA LLC funds.

Percy N. · Answer

@Shera Gregory, what I mean is that you could structure a deal where they get paid a "fee" once you sell and the fee structure would be determined by the amount of time.

Not sure if this would be considered a traditional loan.

Shera Gregory · Answer

@Dmitriy Fomichenko -- my LLC will be providing the funds for the purchase. I am still working out the details with the other party on what entity will actually close on the property. He has it under contract with HUD which cannot be assigned.  There will be a joint tenancy agreement to cover the interests for my LLC and his LLC. But I think your answer would still apply -- the small loan would be to the LLC that is owned by the Roth and is not backed by me personally in any way.

@Percy N. - this is for a rehab but I plan to repay the $5k as a straight loan, not as a share of profits. I didn't want to bring them into the deal for such a small share. My agreement for the repayment of the loan will include the intent to repay in full when the house is sold. Total interest accumulates based on length of time the money is held.

Brian Eastman · Answer

@Shera Gregory

@Dmitriy Fomichenko is correct in explaining that the LLC is the borrower, and so long as the lender is not a disqualified party, that is fine.

The use of debt financing does create exposure to taxation known as unrelated debt financed income (UDFI) which is documented in IRS Publication 598.  With the small amount of debt, you might be under the filing limit, or would have very minimal tax impact, but it is definitely a topic you will want to discuss with your CPA.

Percy N. · Answer

@Shera Gregory, you may want to check with your accountant regarding UBIT

Do you need the $5K for the purchase or as a rehab?

If rehab, can you structure a deal where the person contributes towards the rehab and only gets paid back (with some profit) once the property is sold?

Check with your lawyer and accountant if that is OK with a SDIRA

Dmitriy Fomichenko · Answer

@Shera Gregory

if your IRA owned LLC is buying the property then the loan must be to the LLC as well (not to you personally nor to the IRA itself). The loan must be non-recourse and must be repaid by the LLC. Yes, you can deposit those funds into your IRA LLC checking account.