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Promissory Note Checklist for an IRA

Promissory Note Checklist for an IRA
4 Minute Read

Investing in a promissory note with a Self-Directed IRA is one of the most tax-advantageous investments available. When investing in a promissory note using personal funds, the interest received is subject to ordinary income tax. Whereas, when one uses an IRA, all interest from the note will flow back to the account without tax.

Key Points
  • A promissory note is a written notice to pay someone back money that is loaned to them.
  • One can use retirement funds, such as a Self-Directed IRA to make a loan
  • Payments received from the note, including interest, flow back into the IRA tax free

What is a Promissory Note?

A promissory note is essentially a written promise to pay someone. It is a piece of debt that requires the borrower to pay the lender interest on the amount of the loan. The payment terms can vary. However, it must have interest above the minimum applicable interest rate and should not be higher than the applicable state usury rules. In other words, a promissory note is a lending document that says the borrower promises to repay to the lender a certain amount of money in a certain time frame.

A promissory note can be secured or unsecured. An unsecured note does not offer the lender security in the case of a default by the borrower. In addition, in the case of a business borrower, a promissory note does not provide the lender with an equity interest in the business, since a loan is a debt-based arrangement that requires the borrower to pay back the lender a set amount in a specific time frame.

Before investing in a promissory note with retirement funds, there are several matters to consider.

Investigate the Borrower

Many hard lenders will tell you that a loan is only as good as the borrower’s ability to repay it. Hence, it is vital that an IRA lender thoroughly investigate the financial resources of the borrower to confirm that the borrower is in a viable position to repay the loan.

In addition, a lender who has some concerns about the financial capacity of the borrower should seek security or collateral for the loan in the event of a delinquency in payment. An IRA lender should request the borrower to provide a credit report, statement of net worth, W-2, if applicable, and a copy of three most recent income or business tax returns.

Beware of IRS Prohibited Transactions

Internal Revenue Code Sections 408 & 4975 prohibit the Self-Directed IRA owner and any disqualified persons from directly or indirectly personally benefiting from any IRA investment.

For example, a Self-Directed IRA cannot lend IRA funds to a parent, child, spouse, daughter/son-in-law, or any entity controlled (50% or more ownership) by such persons. However, the IRA owner can lend IRA funds to a brother, sister, aunt, uncle, cousin, friend, neighbor, or any other non-disqualified person.

Promissory Note IRA Checklist

Now that you have a good understanding of what to be on the lookout when you elect to lend IRA funds to a third party, below is a checklist of the key documents involved in a promissory note IRA investment.

There is no need to stress out when looking at the promissory note IRA checklist because the IRA Financial compliance department will make sure you have all the necessary documents to facilitate your IRA loan transaction. In fact, we even have sample promissory notes and other loan docs to assist you. However, many of our IRA lenders do have an attorney to help prepare the loan documentation for the IRA promissory note transaction.

The most important item to remember when using a Self-Directed IRA to enter into a promissory note transaction is how the borrower on the note should be listed. In the case of a Self-Directed IRA, the name of the borrower would be the Self-Directed IRA custodian for the benefit (FBO) of the IRA owner. For example, IRA Financial Trust Company FBO John Doe IRA. Whereas, in the case of a Self-Directed IRA LLC, the name of the borrower would be the name of the LLC that the IRA owns.

The following is a checklist of the key documents involved in a promissory note IRA investment:

AssetRequired Pre-Funding DocumentsRequired Post Funding Documents
Unsecured Promissory Note – Borrower an IndividualInvestment Authorization with funding instructions
• Original notarized note*
• Note servicing agreement (if applicable)  
Amortization/payment schedule (if applicable)  
Unsecured Promissory Note – Borrower a BusinessInvestment Authorization with funding instructions
• Copy of notarized note*
• Copy of assignment of note
• Documents certifying formation of entity
Evidence that the entity is in good standing
• Prohibited Transactions Questionnaire  
Amortization/payment schedule (if applicable)  
Secured Promissory Note – Borrower an IndividualInvestment Authorization with funding instructions
• Original notarized note*
• Note servicing agreement (if applicable)  
Amortization/payment schedule (if applicable)  
Secured Promissory Note – Borrower a BusinessInvestment Authorization with funding instructions
• Copy of the secured note*
• Note servicing agreement (if applicable)
• Documents certifying formation of entity
• Evidence that the entity is in good standing
• Prohibited Transactions Questionnaire  
Amortization/payment schedule (if applicable)  
Promissory Note Secured by Real EstateCopy of deed of trust/mortgage
• Copy of assignment of deed of trust (if applicable)
• Copy of note endorsement (if applicable)
• Evidence that borrower is/will be on the titl  
Recorded deed of trust/mortgage
• Recorded assignment of deed of trust
(if applicable)
• Executed note endorsement (if applicable)  
Promissory Note Secured by VehicleCopy of certificate of ownership in borrower’s name
• Registration of title/lien holder to “IRA Financial Trust Company CFBO
[Investor Name] [IRA Account No.]”
• Evidence that borrower is/will be on the title  
Executed security agreement
• Certificate of ownership  
Promissory Note Secured by EquipmentCopy of UCC filing (if applicable)
• Evidence that borrower is/will be on the title  
Executed security agreement
• Recorded UCC filing (if applicable)  
Secured by Company SharesCopy of security agreement (if applicable)
• Copy of pledge agreement (if applicable)
• Documents certifying formation of entity
• Evidence that the entity is in good standing
• Private Placement Memorandum/Subscription Agreement/Operating Agreement  
Executed security agreement
• Stock Certificate (if applicable)
• Stock Power (if applicable)  
Promissory Note Secured by Participation AgreementCopy of participation agreement
• Evidence that borrower is/will be on the title
• Documents certifying formation of entity
• Evidence that the entity is in good standing
• Private Placement Memorandum/Subscription Agreement/Operating Agreement  
Executed participation agreement  
Promissory Note Secured by Other CollateralEvidence that borrower is/will be on the title
• Applicable security agreement  
Executed security agreement
• Executed certificate of ownership  

Conclusion

Investing in a promissory note with a Self-Directed IRA has many investment and tax advantages. Investment diversification as well as the ability to generate tax-deferred (tax-free for a Roth IRA) income on the loan interest are the two principle advantages.

From a promissory note IRA checklist perspective, the most important item to remember before entering into a loan transaction with a Self-Directed IRA is to verify that the name of the borrower is accurate. The promissory note IRA checklist above will make sure you are aware of all the necessary promissory note documentation for your transaction.

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[10:44 PM] Valerie Marszalek-Boik