A Client asked:

A close friend of mine wants to borrow $100,000 short term and is willing to pay an interest rate of 10%. He has good credit and a lot of collateral. I feel it would be a great loan for my IRA to make. The problem is I only have about 1/2 of that amount in my CheckBook IRA. I do have the balance personally. Would I be committing a prohibited transaction to loan him the difference?

It all depends on how the loan is structured. Provided the friend is not a prohibited party or disqualified person, not only is it legal, it can provide tax savings if structured correctly.

There are three parties involved in this scenario. The borrower, the IRA LLC and you. You and the IRA LLC can NOT have any dealings with each other, however you, personally can deal with the borrower and the IRA LLC may deal with the borrower. The question is: is the IRA LLC dealing with you or vice versa.

First, if your Check Book IRA loans its $50,000 to this person that is a transaction with a non-prohibited party, which is fine. However you’ll still be $50,000 short.

If you, as a private party also make a $50,000 loan to the same party that is fine too because you are dealing with the non-prohibited person, NOT the IRA LLC. Itʼs just a loan between two people, and the two loans are not dependent upon each other.

The fact that you and your CheckBook IRA are making a loan to the same person is acceptable since you and the IRA are NOT dealing with each other.

Think of a first mortgage holder and the holder of a second mortgage. They both are dealing with the same borrower but they NEVER deal with each other. Therefore there is no prohibited transaction in the above example.

TAX ADVANTAGES

A first mortgage will always bring a lower interest rate than a second mortgage. With that in mind, it would certainly be acceptable to make the first mortgage loan to your friend at say 6%, and reserve the second mortgage for the IRA LLC at say 14%, as that mortgage will demand a higher interest rate.

The rates of course need to be somewhere in the vicinity of the normal rates charged by the market, but of course they can be moved up or down depending on the circumstances.

SAME INTEREST, DIFFERENT TREATMENT

The result is the same for the borrower since his interest cost for the entire loan is still 10% or $10,000. However it’s now in two different loans.

It is all a wash to the borrower but you have used the structure to your IRAʼs advantage as it will be collecting 14% on it’s money from an investment that is protected.

IMPORTANT

As there would be two loans from two different parties (one from you personally and one from the IRA LLC), you would need to fund the loans from two different sources. You’d write a check or wire funds to the borrower from your personal account, and you would write a check or wire funds to the borrower from the IRA LLC’s bank account.

Also, the loan payments would come back separately; one check to you personally, and one check to the IRA LLC. Remember these are two separate loans, from two separate parties.

Also remember, with all property loans be sure to secure your collateral properly.

Finally, this is a hypothetical, and you should always consult an experienced attorney or CPA to make sure you are abiding by the rules.