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One of the investing options that is available to individuals with self-directed IRAs is notes, which include various debt-based financial instruments such as mortgage notes, trust deeds and various other interest-bearing securities.
Although individuals who have these retirement accounts have the opportunity to put their money into many different investments, they can learn about transactions that are specifically prohibited by the U.S. Tax Code by reviewing IRS Code 4975.
Individuals who want to use their retirement accounts to invest in notes can do so by purchasing them from various FINRA-regulated entities such as broker-dealers, or from private parties. Fulfilling this task will require the parties to complete either a Buy or Sell Direction Letter.
One type of debt-based financial instrument that individuals can invest in by using self-directed retirement accounts is secured notes, which are backed by specific collateral and therefore generally considered to be less-risky by the investment community. These financial instruments help to lower the risk that the issuer will default on its obligations.
Specific examples of these secured debt-based securities include mortgage notes, which utilize the property that the mortgage was used to buy as collateral. Deeds of trust are another example of secured notes.
The alternative to secured notes is unsecured notes, which are not backed up by collateral. These financial instruments are generally considered to be riskier than secured debt-based instruments by the investment community.
Investors also have the option of purchasing either senior notes or subordinated debt-based instruments. The owners of senior notes have first claim to the proceedings of liquidation if the issuer files for bankruptcy protection. Alternatively, subordinate debt has decreased or subordinate rights in terms of these liquidation proceedings.
These notes are also divided into convertible and nonconvertible securities. Notes that are convertible can be exchanged for equity assets by either the owner of the security or the entity that was responsible for issuing it. This transition is frequently made when an institutional investor purchases an equity interest in the financial entity that issued the convertible note.
Borrowing costs associated with selling these debt-based securities are frequently lower, since they have the option of being exchanged for equity securities. Corporations frequently utilize these notes to raise money for specific projects and also for investments associated with operations.
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