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Recovering Interest Rates Make Private Lending Within IRAs More Attractive

Bad news for borrowers can be good news for lenders. After a very long dry spell, interest rates are starting to nose up out of the cellar. Which means it’s getting more profitable to lend money, as opposed to borrowing it.

At the same time, many folks have been looking at taking some profits in the real estate world, capitalizing on a broad housing recovery over the past several years. Essentially, this reflects a ‘risk-off’ strategy, including potentially de-leveraging retirement portfolios by converting them – wholly or partially – from net borrowers to net lenders.

Outlook for Private Lending in IRAs

The rising interest rate trend is likely to continue for some time. It took a while for interest rates to get as low as they did, and it will take time for them to move back up to healthier and more sustainable rates for net savers.

With that in mind, it’s time to take a look at the potential of using self-directed retirement accounts, such as IRAs, Roth IRAs, SEPs and solo 401(k)s to engage in Private Lending.

Advantages of self-directed IRAs and Private Lending

Normally, interest income is taxed at ordinary income rates. But by lending money from an IRA or other retirement account, you can defer any income taxes due on this interest income. All interest received goes back into your retirement account, where it can be reinvested, instead of going to the IRS and taken out of action, as far as you’re concerned.

The general tax rules concerning traditional versus Roth IRAs apply: Interest income in tradition IRAs as well as 401(k)s, SIMPLEs and SEPs is normally tax-deferred. Interest in Roth IRAs and designated Roth 401(k) accounts grows tax-free, subject to the same 5-year rule that applies to stocks, bonds and mutual funds within Roth accounts.

Penalties for Early Withdrawal

Further, you will have to pay a 10 percent excise tax on amounts you withdraw from an IRA or 401(k) prior to age 59 ½, unless you are over 55 and have left the work force, in which case you can begin taking penalty-free 401(k) distributions once you are older than 55.

A few rules concerning lending from within retirement accounts that most other lenders don’t think about: You can’t take a current tax write-off on bad debts. There was no current income tax due if they paid you, and there’s nothing to deduct against if someone defaults on a loan. Ultimately, you’ll just have less money available for eventual distributions in retirement than you would if the borrower(s) had not defaulted.

Furthermore, traditional IRAs, 401(k)s and SEPs have required minimum distributions (RMDs). You must begin taking income out of these accounts by April 1 of the year after the year in which you turn age 70½.

That means you can’t have your entire portfolio lent out when the deadline comes! If you don’t make your RMDs as required, the IRS can and almost always will levy a 50 percent penalty on any amounts you should have taken as RMDs and didn’t. Ouch.

Prohibited Transactions

It’s always tempting to lend to oneself or to family members. That’s not allowed in IRA accounts, though. Here are the rules:

  • Disqualified persons include the IRA owner’s fiduciary and members of his or her family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
  • The following are examples of prohibited transactions with a traditional IRA.
    • Borrowing money from it
    • Selling property to it
    • Receiving unreasonable compensation for managing it
    • Using it as security for a loan
    • Buying property for personal use (present or future) with IRA funds

To open an account with American IRA, or simply to learn more about the flexibility and benefits of self-directed IRA accounts, including real estate IRAs and IRA partnerships, call us today at 866-7500-IRA(472).

Where to Get The Money Boot Camp

Jim Hitt, CEO at America IRA, LLC, will be attending and will be a guest speaker at this event.                                                                     

Event Location: Dallas, TX

Date: 11/7/2013 – 11/10/2013

Details:

“You Can Get All The Money You Want From People, Not Banks…And Get It Faster, Easier, And There’s No Limit To How Much You Can Borrow.”

Let Alan show you How To Get All The Money You Need To Buy Property Even If Your Credit Is Shot, You’re Broke And Living Paycheck To Paycheck. Imagine it’s two months from now. Your local competitors can never seem to line up financing fast enough. In fact, many of them are afraid to make offers because they don’t know how they’ll finance the deals. But you have an unfair advantage…

Click here for more information.

Self-directed IRA Private Lending

Self-Directed IRA Private Lending Explained

If someone wants to just simply hold the paper secured by an asset in their self-directed IRA, their self-directed IRA is actually going to be a private lender for that asset. That’s right…self-directed IRA private lending simply means a private individual is using their self-directed IRA to loan the money rather than a bank or lending institution.

Self-Directed IRA Private Lending…The Numbers

In this example, Jack Brown has $100,000 he rolls over into his self-directed IRA. He wants to loan it to an investor as a first mortgage on a property worth $135,000.

Self-Directed IRA Private Lending…Determining the Value

Perhaps Jack’s realtor, an appraiser or some resource told him, or perhaps he’s sophisticated enough to look at the deal and say I’m comfortable that the deal is worth $135,000. We always suggest doing your ‘due diligence’ and using professionals to assess the value of an asset you are going to loan money on.

In this case, we’re looking at an LTV – Loan to Value – of 75%. This is not a hard and fast rule, with self-directed IRA private lending, the Loan to value is negotiated between the private lender and the private borrower.

Self-Directed IRA Private Lending…The Terms

The two parties – the lenders as well as the borrower – agreed to a 9% interest rate with interest only payments over five years and no amortization of the loan. With self-directed IRA private lending, the interest rate is negotiated by the private lender and the private borrower. They agreed on a straight interest-only payment, just to make it really clean and easy.

The property is going to be secured by a mortgage and a promissory note, and it’s going to be recorded with an attorney.

 

 

Self-Directed IRA Private Lending…Preparing for the Closing

Jack is going to send us what we call a buy direction letter. It’s an internal document that he completes to tell us the details of what he wants his IRA to invest in.

Jack will then review and approve all the closings documents. He’s the account holder and the decision-maker. He needs to understand the deal, and it’s only going to be funded if Jack is comfortable with it.

Self-Directed IRA Private Lending…The Closing

Even though this loan is being made through his self-directed IRA, this is going to be a regular closing that we’re used to as real estate investors. The documents are going to be recorded, and the only difference is that the original documents are actually going to be held by our office in our fireproof safe at American IRA.

As you can see, we’re not making the decisions. The client is directing us all along the way as to how and when to make the investment. In this case, because it’s a Traditional IRA, the interest is going to be tax deferred in a monthly amount of $750. That’s just 9% of $100,000 broken down into monthly payments.

Self-Directed IRA Private Lending…The Profits

At the end of the five years the loan is repaid, and the interest accrued over those five years is $45,000!

All self-directed IRA private lending investments have inherent risks. With proper due diligence and a professional team, risk can be managed but not eliminated-that is our job as investors. If you don’t want to take a risk whatsoever, tongue in cheek I say “Put it in U.S. Bonds or FDIC Insured CDs…though as you all know…Bonds and CDs are offering very low returns”.

Disclaimer

American IRA, LLC does not give investment advice.  We do offer guidance as to the rules and regulations related to their self-directed accounts and the benefits of different account types so that their clients can take that information to their professionals to discuss the ramifications of various decisions on their individual situation.

For more information, or to explore your options, call American IRA today at 866-7500-IRA (472). We look forward to working with you.