Your IRA can be the lender on a loan backed by real estate. The interest goes back into your IRA, and the property stands behind the loan. Here's how it works, step by step.
I've walked a lot of people through this. The steps are simple. The rules are strict. Get both right and your IRA can earn interest from real estate without you ever becoming a landlord.
The 7 steps
Step 1: Make sure lending fits your plans
Lending ties up money for the length of the loan. Before you start, ask yourself three things. Can I leave this money alone for the full term? Do I need cash from this IRA soon, like required withdrawals from a traditional IRA? Am I OK with the risk that a borrower stops paying?
Step 2: Open a self-directed IRA with the right custodian
Most big brokerages won't hold private loans. Specialty custodians will. Ask each one: Do you allow private notes and real estate loans? What are your setup, yearly, and per-deal fees? How fast do you fund a loan? Compare a few before you pick.
Step 3: Move money in the right way
Transfer from another IRA, or do a direct rollover from an old 401(k). The money should go straight from one custodian to the other. Don't take a check made out to you. That can turn into a taxable withdrawal. Here's how to roll an old 401(k) the right way.
Step 4: Pick the loan, and check who you're lending to
Look at the property, the borrower, and the person running the deal. Search their name and check court records. Here's how I check people out. And make sure the borrower isn't you or a family member. Your spouse, parents, kids, and grandkids are off limits.
Step 5: Review the documents with your own attorney
Your IRA is the lender, not you. So the loan papers name your IRA, usually written like "[Custodian name] FBO [Your name] IRA." You should see a promissory note, a recorded mortgage or collateral assignment, and title work. Have your attorney or CPA review the terms before any money moves.
Step 6: Tell your custodian to fund it
You send your custodian a signed investment direction form, plus the loan documents. The name of the form varies by custodian. The custodian reviews it, signs for the IRA, and sends the money. You never touch the money yourself.
Step 7: Get paid back into your IRA
Every payment goes to your IRA, never to you. Any costs come out of the IRA too. Your custodian may ask you once a year for the loan's value, so keep your payment records handy.
The rules that keep your IRA safe
- No self-dealing. Your IRA can't lend to you or do deals that help you personally right now.
- Family counts. Your spouse, parents, grandparents, kids, grandkids, and your kids' spouses are disqualified persons.
- Keep the money separate. Payments go to the IRA. Costs come from the IRA. Never mix in your own money.
- Skip borrowed money. If your IRA uses leverage, part of the income can be taxed. Most IRA lenders keep it debt-free.
Break a rule and the IRS can treat the whole IRA as withdrawn, with taxes and penalties. When in doubt, ask your custodian and a CPA first.
Want to run the IRA through your own LLC? Read what a checkbook IRA is first. Not sure which type of IRA to use? Read self-directed IRA vs. Roth IRA. You can also see how IRA lending with LJH works.
Common questions
Can my IRA lend money to my son or daughter?
No. Your children, grandchildren, parents, spouse, and your kids' spouses are disqualified persons. Your IRA can't lend to them or do deals with them. Siblings are not on that list, but talk with a CPA before you do any family deal.
Do I pay tax on the interest my IRA earns?
Not while it stays in the IRA. In a traditional IRA, you pay tax when you take money out. In a Roth IRA, qualified withdrawals are tax-free. The interest has to go back into the IRA, not to you.
What if the borrower stops paying?
Your IRA is the lender, so your IRA carries the cost of collecting. Legal fees and other costs have to come from the IRA, not your own pocket. That's why it helps to keep some cash in the account.
Can I lend from my IRA and my own money on the same loan?
Be careful. Mixing your IRA and your personal money in one deal can be a prohibited transaction. Ask your custodian and a CPA before you combine them.
General education, not tax, legal, or investment advice. IRA rules are strict and change over time. Confirm everything with your custodian and a CPA or tax attorney before you invest. All investing has risk, including loss of principal.