Yes, a self-directed IRA can loan money. The account acts as a private lender, funding the loan from its own cash and collecting principal and interest through the custodian. Federal law sets strict limits on who can borrow and how the transaction is structured, and breaking those rules can cost you the tax-advantaged status of the entire account.
Who Your SDIRA Cannot Lend To
The Internal Revenue Code bars loans to anyone classified as a “disqualified person.” That category includes your spouse, any ancestor (parents, grandparents), any lineal descendant (children, grandchildren), and the spouse of any lineal descendant.1Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions Siblings, aunts, uncles, and cousins are not on the list, so your SDIRA can lend to them.
Entities are covered too. If any combination of disqualified persons owns 50 percent or more of a corporation, partnership, or trust, that entity cannot borrow from your SDIRA.1Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions If you and your spouse together own 60 percent of an LLC, that LLC is off limits.
The law also prohibits self-dealing: any arrangement in which you personally benefit from the loan. Receiving a kickback from the borrower, using the loan to support a personal business deal, or having a family member draw a salary from an IRA-funded project all qualify. Even providing a personal guarantee is a prohibited transaction, because your personal creditworthiness would be backing the IRA’s investment.1Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
What a Prohibited Transaction Costs You
The penalty for IRAs is severe. If you or a beneficiary engages in a prohibited transaction involving your IRA, the account ceases to be an IRA as of January 1 of the tax year the transaction occurred. The entire fair market value of every asset in the account on that date is treated as a distribution to you.2Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
That deemed distribution is included in your gross income. Depending on your total income, federal income tax can reach 37 percent.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 If you are under age 59½, a 10 percent early distribution penalty applies on top of the income tax.4Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The custodian reports the event on Form 1099-R using distribution Code 5, which signals the account is no longer an IRA.5Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
IRA owners are exempt from the separate excise taxes that apply to prohibited transactions in employer plans. The trade-off is losing the tax-advantaged status of the whole account rather than paying a percentage penalty on just the transaction amount.1Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
Setting Up the Loan
A formal promissory note is the core document. It identifies the borrower, states the principal, sets the interest rate, and lays out the repayment schedule and maturity date. Terms should reflect what an unrelated lender would offer. A below-market rate or unusually generous repayment terms can raise questions about whether a disqualified person is benefiting indirectly.
If real property secures the loan, a deed of trust or mortgage document names the collateral and gets recorded with the local county recorder’s office to protect the IRA’s claim. For other collateral, such as business equipment, vehicles, or financial instruments, a security agreement serves the same purpose.
Every document must be titled in the custodian’s name on behalf of the IRA, not in your personal name. A common format is “XYZ Trust Company FBO [Your Name] IRA.” This titling makes clear that the IRA, not you, is the lender. If documents list you as the lender, the IRS could treat the funds as a personal distribution.
Once the paperwork is ready, you submit a Direction of Investment form to your custodian. The form tells the custodian how much to send, where to send it, and which IRA account the funds come from. The custodian reviews the documents, generally over a few business days, then sends the funds directly to the borrower or a closing agent. Custodians typically charge a processing fee per transaction and an annual asset-holding fee for alternative investments like private loans. Fee schedules vary, so compare them before opening an account.
Handling Repayments and Changes
All repayments, principal and interest alike, must go directly to the custodian for deposit into the IRA. You cannot collect payments from the borrower personally, even briefly. Routing a payment through your personal bank account, even with the intention of immediately forwarding it, is treated as a distribution to you and triggers income tax and possible penalties.6Internal Revenue Service. Application Procedures for Nonbank Trustees and Custodians
Modifying the loan after funding is allowed, but the new terms must still satisfy the prohibited transaction rules. Any change that shifts value from the IRA to a disqualified person can be treated as a new prohibited transaction.7Internal Revenue Service. Retirement Topics – Prohibited Transactions Reducing the interest rate to help a borrower who is also a business associate, for example, could look like an indirect personal benefit. Document the business justification for any modification and keep the revised terms at market level.
If the Borrower Defaults
When a borrower stops paying, the IRA, not you, has the right to pursue remedies. For a secured loan backed by real estate, that usually means foreclosure. You direct the custodian to initiate the process, and the custodian hires an attorney or trustee to handle it. Costs come out of the IRA’s funds.
You cannot personally manage the foreclosure, negotiate directly with the borrower on your own behalf, or use personal funds to cover the IRA’s legal costs. Any personal involvement beyond directing the custodian crosses into prohibited transaction territory. If the IRA takes title to the foreclosed property, that property becomes an IRA asset and must be held, managed, and eventually sold entirely through the custodian.
For unsecured loans, or loans where the collateral is worth less than the outstanding balance, the IRA may have to write off the uncollected amount. Because the loss occurs inside a tax-advantaged account, you generally cannot deduct it on your personal tax return. That makes due diligence on the borrower and the collateral critical before funding.
Tax Treatment of the Interest
Interest earned inside a traditional SDIRA grows tax-deferred, and withdrawals in retirement are taxed as ordinary income. In a Roth SDIRA, the interest grows tax-free, and qualified withdrawals after age 59½, from an account open at least five years, are also tax-free. Over a long-held loan, this difference can meaningfully change the net return.
Passive interest income from private lending is generally excluded from unrelated business taxable income (UBTI), so most SDIRA loans do not create a separate tax bill inside the account.8Internal Revenue Service. Publication 598 – Tax on Unrelated Business Income of Exempt Organizations The exception is debt-financed income: if the IRA itself borrows money to fund a larger loan, the portion of interest attributable to the borrowed funds can trigger UBTI and require the IRA to file a return and pay tax.9Office of the Law Revision Counsel. 26 USC 514 – Unrelated Debt-Financed Income Most SDIRA loans are funded entirely from existing cash, so this rarely applies to straightforward private lending.
How Much Your SDIRA Can Lend
The loan amount is limited to the cash the IRA already holds. Annual contribution limits apply to new money going into the account, not to the size of loans the account can make.10Internal Revenue Service. Retirement Topics – IRA Contribution Limits An SDIRA can lend any amount up to its available balance, but an account with limited cash has limited lending power, and tying up most of it in a single illiquid loan leaves little room for diversification or unexpected expenses like custodian fees.
Your custodian reports the fair market value of all IRA assets each year on Form 5498, filed with the IRS by May 31.11Internal Revenue Service. Form 5498 – IRA Contribution Information For a private loan, fair market value is typically the outstanding principal balance while the borrower is current. If payments have been missed or collateral has lost value, the valuation gets harder, and some custodians will require a third-party appraisal or a written explanation. Custodians must value trust assets at least once per calendar year.6Internal Revenue Service. Application Procedures for Nonbank Trustees and Custodians