How to Practice Due Diligence with Real Estate Note Investments
Mortgage notes are one of the most popular asset choices for self-directed IRA investors.
These real-estate-backed debt instruments can provide a good mix of principal security and consistent returns. Mortgage notes also offer diversification from the volatility of market-based investments.
But to ensure good results when investing in notes, it’s important to do your homework first.
Investing in the right notes the right way can be a powerful way to grow your retirement savings. And investing in the wrong notes can be an expensive mistake.
Read on to learn how to understand 3 ways to acquire mortgage notes in your IRA, and the key factors to evaluate when considering note investments.
Understanding the Type of Note
There are many kinds of note transactions available in the marketplace, both in terms of how the notes are acquired and how the notes are secured.
Understanding the differences is important to evaluating risk. These differences also determine what areas of diligence you’ll want to focus on when evaluating a specific transaction.
There are 3 primary ways of acquiring notes:
- Originating the note yourself
- Purchasing notes from the originator
- Purchasing notes from a broker
The most common types of notes include:
- 1st Position performing notes
- Junior liens
- Non-performing notes
Types of Borrowers:
- Residential homeowners
- Individual investors
- Corporate investors
The process of originating a note yourself, perhaps as part of the sale of an IRA-held property, is very different from purchasing a discounted non-performing note from a broker.
The following are some of the key factors to evaluate when considering a real estate note investment for your IRA:
Equity in the Property
With performing 1st position notes, or some junior notes, one of the most important factors to consider is equity in the property, or loan-to-value.
If the note value is well below the current market value of the property, that provides a good backstop should the borrower fail to repay the note.
In a foreclosure process, your IRA is likely to come out whole if the loan balance is less than the property value.
If the note is close to or more than the value of a property, it’s a riskier proposition. In some cases, there could be significant equity in a property to cover both a 1st and 2nd note — meaning that equity level becomes a factor for evaluating a 2nd position lien.
In the case of a no-equity 2nd position note, the risk is higher. In this case, other factors would come into play when determining if the note is a good investment.
Location Quality
A property that’s in a good location will hold its value better than a property in a poor location.
Location is a diligence factor that helps you chart the “worst case scenario” risk.
If the note goes into default, will the value of the property be enough to cover the balance of the note, or create the possibility of a favorable exit strategy through deed in lieu or selling the note itself?
A higher quality property paired with a good equity position is a safer bet than a loan with a high loan-to-value ratio in a lower quality location.
Location can also affect regulatory simplicity. Some states are much more lender-friendly than others, or have longer or shorter foreclosure timelines.
Understanding the regulatory environment is important when evaluating the risk associated with a potential default by the borrower.
Borrower’s Ability to Pay
When lending on a short-term basis, like with new-construction or rehab loans, the borrower’s personal finances are usually not a big factor in the lending decision.
The project plan and borrower’s transaction history are generally weighted more heavily. The opposite is true when the borrower is living in the property.
If you’re originating a loan, or purchasing a freshly issued performing note from a broker, then detailed underwriting should be a part of your process.
It may make sense to involve a professional licensed loan originator who will have a structured process for analyzing a borrower’s overall financial situation. This can include credit scores, income, existing debt, potential judgements, etc.
When evaluating resale notes or non-performing notes, payment history is just as important as the overall creditworthiness of the borrower.
The longer someone has been successfully making payments on a loan, the more likely they are to continue paying, even if they have certain financial stresses.
This payment consistency is a positive both for payments from day one of the loan, and for situations where a borrower in arrears has started getting caught up. The longer they’ve been doing so, the higher the likelihood of success.
Other Liens
Making sure there is no risk of other senior liens against a property is important — especially with new loan originations.
You’ll want to be sure there are not outstanding liens associated with real estate taxes, homeowner’s association dues or insurance.
Even if there aren’t any outstanding liens, you still want to have a handle on these factors, as they could turn into senior liens of a borrower fails to pay on these items.
Regulatory Considerations
No matter how good the numbers and other factors related to a note purchase may be, a mortgage may be unenforceable if it’s not properly documented.
You’ll want to ensure that all necessary state regulations have been followed with respect to the underwriting of the loan, as well as the documentation and recording of the mortgage.
It’s important to work with a licensed professional familiar with the lending laws of the state, as each state has different rules.
Work with Professionals
While private lending transactions can be a great investment for your self-directed IRA or Solo 401(k), there are many considerations that go into selecting the right investment notes.
It’s important to ensure that the documentation of the loan is thorough and in compliance with state lending laws.
Working with a licensed mortgage broker, title company, or real estate attorney is the best way to protect your interests and ensure your mortgage contract is enforceable.
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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.
