Consequences of loss on unsecured note held in Self Directed IRA

[Mark Carson]

Hi - I'm looking for some advice on resolving a SDIRA issue:

My Self Directed IRA made a unsecured loan to an individual (not a disqualified party).

The borrower is unable to repay the loan according to the terms of the note. I want to now accept a partial repayment as payment in full and close out the note resulting in a loss to my IRA.

Note that there isn't a third party "Loan Servicing Agent" for this loan because the custodian did not require one at the time the loan was made (I noticed that they now do require one).  

Questions: 

- Is there any special reporting required because of the loss?  If so, who does the reporting (me or the custodian)?

- Is the borrower technically liable for tax on the loss amount? 

- Do the repayment funds sent to the account custodian have to come directly from the borrower, or can he give them to me to send to the custodian from my own bank account? (I am wondering if sending from my own account somehow makes it a prohibited transaction.)

Anyone have any good advice about how to resolve this cleanly?

Thanks!

[Jaime Raskulinecz]

It is a great idea to consult with your CPA or tax advisor. However, I can answer a couple of these questions for you @Mark Carson.

The funds will have to come directly from the Borrower into your IRA account with the current custodian. This is essential.

You should ensure that you fully document the reason for your decision to have your IRA write off part of the loan and accept a lesser amount as payment in full.

Typically, your custodian will accept your instructions to "sell" the note (accept a reduced payment in full and take the loan off the books). You will now have cash in your IRA account instead of a loan for whatever face amount the original loan was.

If you keep the cash in your existing IRA account, when the custodian does Fair Market Value reporting to the IRS your account value will be reported at the reduced amount. If you transfer the cash to a different custodian, the new custodian will report the Fair Market Value of the account.

Because this investment was held in a tax advantaged account you don't report and deduct any losses.

Please let me know if I can answer any other questions.

Jaime