Trust-deeds are a little-known but long-established investment niche popular with private lenders, and many Self-Directed IRA owners.
In a trust deed loan, a Self-Directed IRA owner would make a private loan to a borrower with the loan secured by some specific collateral – generally in the form of real estate. However, the market isn’t just individuals and their retirement accounts. Pension funds and other institutions seeking to diversify their portfolios against stock market and bond market risk also frequently allocate a portion of their portfolios to trust-deed loans.
The difference between a straight-ahead secured mortgage and a trust-deed loan is that in the latter, the deed is physically given to a third party, with instructions on what is to be done with the deed in the event of a default, or in the event the loan is paid off. Loans can be of any length, but terms of 1-3 years are common.
This lending structure is commonly used in Alaska, Arizona, California, Colorado, Idaho, Illinois, Mississippi, Missouri, Montana, North Carolina, Tennessee, Texas, Virginia and West Virginia.
For Self-Directed IRA owners willing to take on concentrated positions, and possibly become instant landlords in the event of a loan default, trust deed investments can be a viable way to eke out much more income yield out of their investment compared to other fixed income alternatives. For example, while 2-year treasury yields have tumbled to 0.787 percent, as of this writing, trust deed borrowers frequently pay anywhere from 5 to 10 percent yields and sometimes more, depending on the nature of the investment and the collateral put up.
There are seven essential elements to trust deed lending that Self-Directed IRA investors should understand:
- Market value and equity in the property put up as collateral
- The knowledge and experience of the mortgage loan broker
- The financial standing and credit worthiness of the buyer
- The escrow process involving the funding of the loan or the purchase of the promissory note
- Documents and instructions describing and securing the loan or purchase of the promissory note
- Loan servicing provisions, authority and compensation
- Recovering your investment in the event of default.
Each of these essential elements is discussed in more detail in this publication from the California Department of Real Estate.
If you are using capital from a Self-Directed IRA, 401(k), SEP or SIMPLE, you should be aware of the required minimum distribution rules. Trust deed lending can offer good yields, and the security offered by the underlying real estate can make the asset class very attractive for patient investors. But these notes are usually very illiquid. Most Self-Directed IRA investors interested in trust deed lending should not rely on the principal from these assets to meet required minimum distributions or to meet short-term living expenses. However, regular interest payments usually help a great deal with the living expense and RMD issues.
Self-Directed IRAs Are Ideal For Trust Deed Investing
Self-Directed IRAs are usually excellent vehicles for trust deed IRAs because there is no tax consequence to income generated within these accounts until you actually pull the money out. Since the income generated by trust deed investments is normally taxable as ordinary income, the tax efficiency of the type of account you use is important.
To get started, open an account with American IRA, LLC, at www.americanira.com. Feel free to call us at 866-7500-IRA(472) for any information or assistance you may need.
Once you have funded your account, find a willing borrower, agree on an interest rate and collateral, and have your attorneys or a trust deed investment company set up the documents with the escrow company.
Then tell us where you need us to wire the money in order to fund the loan.
It’s important to have all interest payments go back to the IRA. So inform your borrower or escrow company to send those funds to us to credit your account. Otherwise you may cause an accidental distribution, resulting in unwanted taxes and penalties.
If you require income or distributions from your IRA, notify us and we will promptly send those funds to you, with all documentation fully compliant with tax law.