Using Self-Directed IRAs for Real Estate Investments: Benefits and Risks

Why Investors Use Self-Directed IRAs for Real Estate

Most retirement accounts are built around mutual funds and ETFs. If you ask a typical brokerage whether you can buy a rental property inside your IRA, the answer often sounds like “no,” when the real answer is “not on this platform.” The tax rules have allowed real estate in IRAs for decades—you just need the right structure and discipline.

A Self-Directed IRA (SDIRA) opens that door. It lets you use retirement dollars to buy tangible assets like rentals, commercial buildings, or land. The trade-off is that the rules are more complex, and mistakes carry higher stakes than in a conventional portfolio.

How a Self-Directed IRA Differs From a Standard IRA

At a high level, a self-directed IRA is still an IRA. Contributions, distribution rules, and basic tax treatment follow the familiar patterns for traditional or Roth accounts. The key difference is the custodian. A specialized SDIRA custodian agrees to hold assets beyond the usual menu of stocks and bonds and to process transactions on your instructions.

That added flexibility brings responsibilities:

• You are responsible for selecting investments; the custodian does not vet deals for quality.
• All income and expenses must flow through the IRA, not your personal accounts.
• You must avoid prohibited transactions and disqualified persons to keep the IRA’s tax advantages intact.

Understanding these boundaries is essential before you move funds or sign purchase contracts.

Tax Advantages of Owning Real Estate Inside an IRA

The main attraction of using an SDIRA for real estate is tax treatment:

• Traditional SDIRA. Rental income and gains grow tax-deferred. You pay tax only when you take distributions, typically in retirement.
• Roth SDIRA. Qualified distributions are tax-free. If you meet the holding and age requirements, rental income and appreciation can ultimately be withdrawn without additional tax.

In both cases, activity inside the account does not trigger annual income tax filings the way it would if you owned the property personally. That can make long-term, compounding returns more efficient.

Prohibited Transactions and Disqualified Persons

The IRS places strict limits on how you can interact with assets in your SDIRA. Violating these rules can disqualify the entire account, effectively treating it as distributed and taxable.

Key concepts include:

• Disqualified persons. Generally you, your spouse, certain family members, and entities you control are treated as disqualified. They cannot buy from, sell to, or personally benefit from IRA-owned property.
• No personal use. You cannot live in, vacation in, or let close family use an IRA-owned property, even briefly.
• No sweat equity. You cannot personally perform repairs or improvements on IRA property. All work must be done by third parties paid from IRA funds.

These restrictions feel counterintuitive to investors used to active involvement. In an SDIRA, your role is closer to a passive owner giving instructions, not a hands-on landlord.

Funding and Financing Real Estate in an SDIRA

Purchases inside an SDIRA are funded with IRA cash, rollovers from other retirement accounts, or, in some cases, non-recourse loans. Conventional mortgages that rely on your personal guarantee are not allowed.

If you use leverage, additional rules can apply:

• Non-recourse loans only. The lender’s claim is limited to the property; you cannot personally guarantee repayment.
• Unrelated Business Income Tax (UBIT). The portion of income and gain attributable to leveraged funds may be subject to UBIT, even inside an otherwise tax-advantaged account.

This does not mean leverage is off the table, but it does mean you should model after-tax outcomes carefully before borrowing inside an IRA.

Liquidity, Expenses, and Required Distributions

Real estate is illiquid, and retirement accounts come with timing requirements. It is important to plan for:

• Ongoing expenses. Property taxes, insurance, repairs, and HOA dues must all be paid from IRA funds, not your personal accounts. Keeping a cash cushion in the IRA is essential.
• Required Minimum Distributions (RMDs). For traditional SDIRAs, RMDs begin at the applicable age. If most of the IRA’s value sits in property, you may need to plan partial sales or ensure enough cash is available to meet distribution requirements.

These constraints do not make SDIRAs unworkable, but they do require looking several years ahead instead of treating each property in isolation.

When a Self-Directed IRA Can Make Sense

SDIRAs are best suited for investors who:

• Already understand real estate investing and want to extend that expertise to retirement funds.
• Are comfortable working with specialized custodians and additional paperwork.
• Have a long time horizon and do not need near-term access to the invested cash.

If your primary goal is simplicity, or if you rely on your retirement accounts for short-term liquidity, directing those funds into physical property may not be the right fit.

When to Consider Other Approaches

In some cases, it may be more practical to:

• Keep retirement accounts in simpler investments and buy real estate personally or through LLCs.
• Use real estate-focused funds or publicly traded REITs inside traditional IRAs, avoiding SDIRA complexity.
• Combine approaches, reserving self-directed strategies for a small portion of total retirement assets.

The goal is not to force real estate into every corner of your portfolio. It is to match tools to your risk tolerance, administrative capacity, and long-term plans.

Handled thoughtfully, self-directed IRAs can extend the reach of your investing strategy. Handled casually, they can create avoidable tax and compliance problems. The difference usually comes down to preparation, clear boundaries, and a willingness to ask for expert help before—not after—you sign a contract.