Private Lending in an IRA

Case Study: Private Lending

The case study below details how two real estate investors struck a mutually beneficial IRA private lending deal to invest in a rehab-and-flip project.

Shawn has found a fix-and-flip project he wants to purchase, but he needs help with funding. He needs $150,000 to buy the property and $50,000 for the renovation.

Before and after pictures of a kitchen renovation projectMaria has $250,000 in a self-directed IRA and is interested in partnering with a rehabber to flip a house. Since her IRA will be the partner in the transaction, all gains revert directly into her IRA on a tax-deferred basis.

Maria and Shawn meet at a local investor group. Maria likes Shawn but needs to perform her own extensive due diligence before entering into a partnership. She determines Shawn is a suitable partner, and that the property is a legitimate investment with great potential.

Shawn and Maria work out the details of their partnership, which will be between Shawn and Maria’s IRA. Shawn agrees to use the property as collateral as Maria’s IRA will loan him the full $200,000 for the investment property and rehab expenses.

As the IRA owner, Maria sets the terms of the loan to Shawn. Here are two examples of how the loan can work

Different Ways to Structure IRA Private Lending Transactions:

  1. Repayment of loan based on interest only payments (on top of repayment of loan principle)
    • Loan amount: $200,000
    • Interest rate: 12%
    • Points/loan origination fee: $2,000
    • 2-year balloon note
    • Monthly payments: $2,000
    • Secured by first mortgage on the property
  1. Loan repayment that includes portion of the investment profit as payoff
    • Loan amount: $200,000
    • Interest rate: 5%
    • Percent of profits at sale of property: 40%
    • Monthly payments:  $833
    • Secured by first mortgage on the property

Maria chooses option 2 and structures the loan so her IRA receives a portion of the profits from the investment.

The Investing Process:

  • Maria has her attorney prepare the note and mortgage, and lists Maria’s IRA as the lender.
  • Once the documents are prepared, Maria forwards them to Advanta along with a Notes Purchase Authorization Form, detailing the terms of the note with Shawn.
  • Maria’s account manager at Advanta IRA reviews the documents to ensure all documents reflect the proper wording for Maria’s IRA as the lender.
  • Maria’s account manager returns the documents to her to fully review and approve the loan document and its provisions.
  • Upon receipt of Maria’s approval, her account manager initiates the transfer of funds from Maria’s IRA to the closing agent.

The Payoff:

After 6 months, Shawn is ready to sell the property for $260,000 (net after closing costs)

  • He requests the payoff amount from Maria.
  • Maria provides a payoff letter with the amount due.
  • The payoff letter is sent to the title company handling the closing.

The Profit:

Maria’s IRA and Shawn both benefit from their partnership.

Maria’s IRA’s return on the investment:

  • Repaid principal: $200,000
  • Monthly payments: $5,000
  • Percentage of profits: $24,000 (40% of the $60K profit)
  • Total earnings: $29,000
  • Return: $29,000 in tax-deferred earnings on an investment of $200,000

Shawn’s earnings:

  • Original loan: $200,000
  • Sale of house: $260,000
  • Repayment of interest and profits: $29,000
  • Total earnings: $31,000

Through this partnership, Maria’s IRA earned income that she can turn around and reinvest.