Investing in notes within a self directed IRA

5 Replies

I frequently read that investors purchase their notes within a self-directed IRA. I understand the idea to be that the capital gains associated with the interest payments the borrower pays the note holder are then not taxed. Just so I am clear, when investing in notes in this manner, it is assumed that money placed in the self-directed IRA will not be touched until the age of retirement, correct? Meaning, I shouldn't invest in notes (or any other asset class) in my self-directed IRA unless I am prepared to not touch that money I until I retire and that is what most people who are buying notes in the IRA are doing? Am I understanding this correctly? I also understand that the money can be pulled out before retirement, but would then be taxed? Is that correct?

That is correct. Remember that your SDIRA is a separate entity than you, and you cannot personally access any funds in that account until you reach at least 59 1/2. Even at that point, it needs to be disbursed from the custodian. There likely will be some other IRA folks chime in after my reply with additional details, but essentially you are correct.

I'm pretty sure that if it's a traditional SDIRA,  the gains would still be taxed when you pull them out, even if you are over the age limit. With a Roth SDIRA, the gains would not be taxed on a disbursement after retirement age. 

In either case, if you pull out money before retirement age, you have to pay a penalty. 10%, I believe. 

You are correct that investing in promissory notes and any other type of a allowed investment using an IRA will continue to grow on a tax-deferred basis. Investing in promissory notes is another way of growing your IRA. Anytime distributions are processed from the traditional IRA, federal taxes will apply. State taxes may also apply depending on your state of residence and also a 10% early distribution penalty will apply if you are under age 59 1/2.

Bottom line, investing an IRA in promissory notes is simply another way of diversifying your nest egg.

Eran,

It doesn't matter if you use your IRA funds to invest in stocks or in notes: you won't be able to benefit from those investments now. Retirement accounts are designed for future benefits.

Investing in notes however will likely produce higher returns, less risky and gives you more control comparing to the stock market (assuming you've done your due diligence).

One thing to add...

IRA owners are restricted from providing services beyond basic functions such as signing agreements, paying bills, depositing income, and making decisions as to investments or engagement of business services.

I suspect some investors may play an active role on resolving non-performing notes in their self directed accounts, but there is a restriction against providing services which contribute value. 

In my view, performing notes managed by a Servicer, non-performing notes (NPNs) under a JV where your partner is providing the workout sweat equity, or NPNs where the workout efforts are outsourced to a 3rd party asset manager are good fits for a retirement account. If you plan to roll up your sleeves though, in my view it's not a fit for the retirement account.

Note: I'm not an attorney or tax professional. Be sure to seek professional advice.

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