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Buying secured notes in retirement accounts offers two important benefits: limited exposure to stock market uncertainty, and  income not linked to publicly-traded corporate or municipal debt. Many investors are also attracted by the opportunity to diversify through trust deeds and mortgages. But what else do you need to know?

What is a Trust Deed Investment

A trust deed investment is a loan to a borrower that legally encumbers real property. The promissory note outlines the borrower’s terms and obligations to the investor, including interest rate, payment date, default provision and a maturity date. The promissory note is secured by a mortgage or Deed of Trust against the property in favor of the investor. The deed is filed on record with the property’s local office of the County Recorder.

In the event of default of the terms set by the promissory note, the Deed of Trust allows the investor to foreclosure against the borrower. Foreclosure may result in investor ownership of the property, which can then be sold to recover investor funds. The investor’s position is further secured by title insurance, which protects against loss from title defects, liens and other matters.

Growing interest

Notes secured by real estate are a fast-growing investment category as alternative-asset investing becomes more common. Besides having tangible collateral, many investors are attracted to the overall protection that trust deeds and mortgages provide because property is expected to not lose all of its value. Investors can mitigate the risk of damage or destruction with property insurance.

Limitations on structured notes

When choosing a custodian to assist with one’s retirement account and the facilitation of the note investment, it is important to understand what kind of investments each will allow, what they will not and why.

Each custodian is allowed the flexibility by the Internal Revenue code to determine what assets they will custody, with few exceptions, and many do not accept unsecured notes to entities—i.e. LLCs, LPs, or other private equity companies. Why? Unsecured notes have been identified as high-risk for illicit deals, fraud and unsound investment practices and so receive special regulatory scrutiny after provisions such as the Bank Secrecy, Anti-Money Laundering and Patriot Acts.

Additionally, to avoid engaging in a “prohibited transaction” the IRA cannot transact business with certain “disqualified” individuals as they relate to the IRA owner. A disqualified person is defined as:

  • The accountholder owner 
  • The accountholder's spouse 
  • Ancestral descendants (mother, father, grandparents) 
  • Lineal descendents (daughters, sons, grandchildren) 
  • Spouses of lineal descendents (son or daughter-in-law) 
  • Investment advisors 
  • Fiduciaries—those providing services to the plan 
  • Any business entity e.g., partnership, corporation, Trust or LLC in which any of the disqualified persons identified above has a 50 percent or greater interest.

Prohibited transactions include the following (A full list can be found on NuWire's self-directed IRA rules page)

  • The sale, exchange, or leasing, of any property between a plan and a disqualified person. 
  • The lending of money or other extension of credit between a plan and a disqualified person. 
  • The furnishing of goods, services, or facilities between a plan and a disqualified person.
  • The receipt of any consideration for his/her own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

Successful structured note investments

A properly structured note should meet retirement plan guidelines by ensuring that the borrower is not a “disqualified person” according to IRC 4975 to avoid entering into any “prohibited transactions.” The self-directed IRA owner cannot have any affiliation with the underlying collateral or the IRA funds after disbursement from the account, and there must be a reasonable rate of return for any note investment. If the note is secured by anything other than real property, a UCC (Uniform Commercial Code laws regulating commercial transactions) filing is required.

Once you consult with an attorney, broker, note issuer or anyone else qualified to determine if the note is properly structured (and recordable), vesting would be in the name of the IRA.

After the note is funded by the self-directed retirement account, the original note and original recorded deed should be returned to the custodian for safekeeping. The custodian will hold the originals until payoff, sale, or some other activity that would require surrendering the original. If a third-party loan servicing agent is used, often they may keep the originals. In any case, custodians will require copies of the recorded documents to ensure that they have documented evidence of ownership.

As investors continue exploring alternatives to traditional investing methodology, a good advisor and custodial firm well versed in alternative investments may expose SDIRA owners to the process, simplifying mortgage, note or trust deed investment transactions.