Promissory Note Overview
Definition
A promissory note is an extension of credit or a promise to pay between one or more parties and another or other parties. Unlike a secured loan, there is no collateral supporting the obligation in the event of default by the borrower.
Types of Loans
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Promissory Note between an IRA and an Individual
When a promissory note is between an IRA and an individual, it is only the reputation and creditworthiness of the borrower (individual) that the lender (IRA) is relying on for repayment. As a result, promissory notes are much higher risk than secured loans and for this reason they are most common between family and friends. With IRAs, however, there are restrictions for certain intra-family transactions (click here for prohibited transactions).
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Promissory Note between an IRA and an entity (LLC, C-Corp, etc.)
Promissory notes between an IRA (as the lender) and a corporation (as the borrower) are even rarer than personal loans, because an entity doesn't have to stake its personal reputation on the line. However, they are more vulnerable to lawsuits in the event of default. In addition, care must be taken to avoid lending to a company that is owned 50% or more by "disqualified persons" (e.g. direct relatives and the spouse of the IRA owner and including the IRA owner's personal stake in the entity at the time of the IRA's investment).
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