Diligence Series: Construction Loans
There are many different types of loans you can make with a self-directed IRA or Solo 401(k). Lending to developers or their contracted purchaser for new home development is a popular option.
Many developers prefer to work with private lenders on these projects. If you do a little networking, it can be easy to locate these types of opportunities.
Because construction loans carry a few additional risk factors and are generally somewhat short term, they aren’t a favorite product for many banks.
When banks will lend for new construction, they often introduce so much paperwork complexity and additional fee layers that it can make the loans somewhat undesirable for builders.
Therein lies the opportunity: As a private lender using your IRA, you can be easier to work with. You can even charge a slightly higher interest rate in exchange for simplicity.
To a builder, time is money. The last thing they want to do is spend hours at a bank.
Easy to work with does not, however, mean that you should issue a big check out of your IRA just because you happen to like a builder you know. Lending for new construction requires proper diligence to ensure you minimize risk and maximize the chance of a favorable outcome.
Start with a Good Attorney
While it’s always important to have legal counsel to keep you on the right track and look out for your interests, this becomes an especially important consideration in specialty lending transactions such as for construction loans.
If you don’t have an attorney with specialty knowledge in this field in your list of contacts, reach out to title companies or attorneys. They’ll know who in your community knows what they’re doing, since they end up recording the notes.
Know the Builder
Whether your borrower is the builder or the homeowner who is hiring the builder on their behalf, no one person has more impact on the success or failure of a development project than the builder.
Be sure to evaluate the track record and level of experience the builder has. Have them provide a portfolio of completed projects and outline whether they were finished on time and on budget or experienced difficulties.
In some cases, you may be able to corroborate the facts with title records for the subject properties. A background check is never a bad idea and is relatively easy to obtain.
It’s also important that the builder can exhibit proficiency in dealing with the local municipality. Are they familiar with the application and permitting processes? Do they have a realistic vision of the time impact that code compliance will have on the project?
In some regions, you may be able to see if they have code violations on prior projects.
Licensing and Insurance
You’ll want to make sure that the builder as well as any potential sub-contractors carry the appropriate licensing and insurance for the project. Don’t just ask, but require that policies be presented as part of the loan underwriting review.
Evaluate the Project
Any time your IRA or 401(k) is lending money, it is critical to understand what the underlying security for the loan is. In a new construction loan, that can be a moving target.
At first there may only be an unpermitted plot of land. Will infrastructure such as roads and utilities be in place before the loan is issued, or is site development part of the project?
Infrastructure takes time and money. Whether your loan includes capital for that purpose or not, the project does not move forward until site work is complete. Be sure you understand where the project you are lending on begins.
It’s important to review the project plan and ensure that it’s reasonable with respect to timing, and how the various phases of construction will fall in place. The more you know about how homes are built, the better you’ll be able to validate a plan.
If you’re not an expert, perhaps having an experienced 3rd party look over a plan will be to your benefit. With a builder who has plenty of relevant history building in a specific community, checking their work on the plan may be less critical.
Think about potential obstacles and contingencies. What happens if there are delays with permitting or due to weather? If framing scheduled to take place in May gets pushed to June, will the roofing sub-contractor still be available, or will an alternate need to be found?
It’s perhaps unrealistic to expect a builder to have answers for every possible contingency. What’s important is to see that they realistically expect obstacles to pop up and have experience minimizing the impact of such problems.
Of course, the dollars have to make sense, too. It should be pretty easy to determine the build cost per square foot of similar projects.
The potential selling price of the finished home should also be something you can evaluate and verify within reason. Do the numbers add up? Is there a reasonable profit for the builder in place, even if delays occur?
Note Design
With new construction finance, the terms of a note are generally more complex than other lending arrangements. It’s important to ensure you have a solid contract that protects your interests at various stages, and ensures measurable goals are met before capital is released in appropriate stages.
Again, the importance of having a quality attorney help in this area cannot be understated.
Some of the concepts that can be unique to construction lending include:
Performance Bonds or Guarantees
- Such bonding should be a standard part of a construction loan.
- You want to ensure that the lender guarantees completion and cannot simply walk off the job.
- Likewise, you may want to see a payment bond in place that requires all subcontractors and materials suppliers to be paid even if the contractor fails to do so.
- This reduces your potential exposure to claims from those ancillary parties in the event of project failure.
Staged Payments with Appropriate Terms
- In most construction lending arrangements, funds are released to the borrower in phases, once completion of certain milestones are met.
- How many such stages will be appropriate and what level of funding should be released at each stage is variable depending on the nature and scope of the project.
- What you as a lender want to ensure is that you release enough funds to allow the builder to keep moving forward efficiently, but not so much as to create unnecessary exposure.
- In some larger projects, it may be appropriate to document payment to subcontractors and have them issue a partial lien release.
- You also want to make sure there is a reasonable amount of time between the builder’s statement of completion of a project phase and a requirement to deliver the next round of funding.
- It will be necessary to verify completion and execute a funding transaction, all of which takes time.
Retainage
- A good lending contract will retain some of the borrower’s payments until major milestones are met.
- This tactic helps to drive the contractor to complete the project in a complete and professional manner.
- One might withhold 10% until the project is half-way done and then 5% until the project is fully completed and signed off on.
Reserves
- The capital being lent should only be part of the builder’s overall project cost.
- You may want to specify that the builder demonstrate a certain amount of liquid reserves and verify the continued availability of such reserves over the course of the project.
- With a performance bond, this may not be necessary.
Completion Deadline & Damages for Failure to Complete
- In some types of construction projects, it may be appropriate to establish a deadline and a penalty paid by the builder for failure to complete the project by that date.
- Such language is often used in larger commercial projects where income to the lender/property owner does not start generating until project completion.
- Each day a project goes unfinished therefore represents a cost in terms of revenue lost.
- For construction of a residence, this may not be as much of a day-to-day factor but could be looked at in terms of months beyond scheduled completion.
Terms of Completion
- Be sure the loan contract specifically outlines what both parties view as completion of the project.
- The last thing you want to have happen is a situation where the developer thinks they are done and should be paid in full, but the property has necessary components unfinished.
- Clarity on this point before starting can reduce a lot of potential headache.
Recording and Servicing
- In order to be truly enforceable, a note must be recorded.
- You should never make a loan from your self-directed retirement plan without having it documented with the local county records office.
- For simple notes with less complex terms, it’s possible to self-administer the loan. With larger and more complex contracts, it can be beneficial to have a 3rd party servicing company handle the note and ensure the contract is adhered to.
Acting as a construction lender can be a good way to generate above-average returns in short to mid-term projects. The overall risk-reward-liquidity balance can be favorable.
The best way to obtain a minimum amount of risk is to perform proper diligence on the project and the note contract itself. And remember, when your self-directed IRA requires the use of an attorney, the cost of those legal services should be paid by the plan, not by you.
It’s often appropriate to include such legal costs as part of up-front loan fees paid by the borrower.
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Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
