Retirement Planning

A Complete Guide to Real Estate Investing with a Self-Directed IRA

A Complete Guide to Real Estate Investing with a Self-Directed IRA

¹The following article is provided for educational purposes only and does not constitute personalized investment, tax, or legal advice. Any examples are hypothetical and for illustrative purposes only. Investing involves risk, and outcomes may differ materially from any projections or scenarios discussed. Readers should consult with a qualified financial, tax, or legal professional regarding their individual circumstances

Consider John, a retiree who spent decades saving in his IRA. Instead of keeping his portfolio in mutual funds or bonds, he used a Self-Directed IRA to buy a duplex. Over time, rent checks flowed into the account and the property appreciated, giving him more flexibility in retirement.

John’s story illustrates a broader trend. According to the Investment Company Institute, U.S. retirement assets totaled $43.4 trillion in Q1 2025, with IRAs making up $16.8 trillion. Yet many investors still believe their IRA funds must remain in public markets. In reality, an SDIRA can own real estate—residential, commercial, or rental—if IRS rules are followed carefully.

This guide explains how real estate investing works within an SDIRA, the custodian’s role, how income is taxed, and the compliance pitfalls to avoid.

Key Points to Know

  • SDIRAs allow real estate ownership, but all activity must comply with IRS rules on prohibited transactions and disqualified parties.
  • Every account must be held by a custodian, even though the investor directs the investments.
  • Rental income typically grows tax-deferred (Traditional) or tax-free (Roth), but certain activities may trigger Unrelated Business Income Tax (UBIT).
  • All property-related cash flows—both income and expenses—must run through the SDIRA. Mixing in personal funds is prohibited.
  • Real estate inside an SDIRA brings operational complexity, compliance demands, and liquidity limits, making due diligence essential.

Advantages of Real Estate in an SDIRA

While regulations are detailed, there are clear benefits for some investors:

  • Diversification beyond stocks and bonds.
  • Potential for consistent rental income in a tax-advantaged account.
  • Inflation hedging through physical asset ownership.
  • Flexibility to invest in different types of property, subject to IRS rules.
  • Direct control over property type and location—within compliance boundaries.

1. How Real Estate Investing Works in an SDIRA

From a tax standpoint, a Self-Directed IRA functions like a traditional IRA, but the menu of investments is broader. Nearly anything is permitted, except life insurance and collectibles. That means property can be purchased, but assets like artwork, wine, or rare cars are not allowed.

How it works:

  1. Open an SDIRA with a qualified custodian.
  2. Fund the account through contributions, transfers, or rollovers (subject to IRS limits).
  3. Direct the custodian to purchase property in the IRA’s name.
  4. Ensure that all rental income and expenses flow through the account to preserve tax status.

A critical detail: the investor cannot hold the property title personally. It must be titled to the IRA itself, and all legal documents must reflect that.

2. IRS Rules and Prohibited Transactions

The biggest compliance hazard is self-dealing—using the IRA’s property for personal benefit. Examples include:

  • Living in the IRA-owned property.
  • Renting it to immediate family members.
  • Personally repairing or maintaining the property (“sweat equity”).

Breaking these rules can disqualify the IRA, making the entire account taxable and subject to penalties.

“Disqualified persons” include the account holder, spouse, parents, children, certain in-laws, and any business entities under their control. These restrictions are absolute.

3. Taxes and UBIT Risk

Inside an SDIRA:

  • Traditional SDIRA: Rental income is tax-deferred until withdrawals.
  • Roth SDIRA: Qualifying distributions are tax-free.

However, complications arise when leverage or business activity is involved. If an SDIRA property is mortgaged, or if the account engages in activities like house-flipping, Unrelated Business Income Tax (UBIT) may apply.

  • Hypothetical Example: If a property generates $10,000 in income, with $3,000 tied to debt, UBIT at 37% would mean $1,110 in taxes, reducing net income to $8,890.

Understanding UBIT is crucial to evaluating whether an SDIRA real estate investment is viable.

4. The Custodian’s Role

Even though the investor directs investments, the IRS requires a custodian to hold assets, execute paperwork, and file reports. The custodian does not give investment advice; their role is administrative and compliance-focused.

Some investors use “checkbook control” LLCs, where the SDIRA owns an LLC that manages transactions. This structure offers flexibility but also raises the risk of errors if not carefully overseen.

5. Operational Realities

Owning property in an SDIRA means handling unique logistical challenges:

  • Expenses — all costs (repairs, taxes, insurance) must be paid by the SDIRA.
  • Income — rent and sale proceeds must be deposited back into the SDIRA.
  • Liquidity — selling property to fund required distributions may take time.
  • Valuation — custodians often require annual valuations for IRS reporting.

Hypothetical Illustration: An investor buys a $200,000 rental property inside an SDIRA. The $1,500 monthly rent is deposited into the account. A $5,000 roof repair comes due—payment must come from the IRA’s funds, not personal accounts.

Risks and Common Mistakes

Real estate inside an SDIRA can be rewarding, but mistakes are costly. Common challenges include:

  • Prohibited transactions that disqualify the account.
  • Illiquidity, especially when required minimum distributions (RMDs) come due.
  • UBIT liability from debt-financed or business-like activities.
  • Cash flow shortfalls if the SDIRA lacks funds for maintenance.

The lesson: success depends as much on respecting IRS rules as on picking the right property.

Investing in real estate through an SDIRA can diversify retirement savings and offer tax advantages. But the rules are unforgiving, and even small errors can lead to large consequences. The most prepared investors approach compliance as seriously as property selection.

Self-Directed IRAs & Real Estate — FAQs

What types of assets are explicitly excluded from SDIRA investments?
Collectibles such as art, wine, and vintage cars are prohibited, along with life insurance. These exclusions help prevent unintentional violations of IRS rules.
Who counts as a “disqualified person” in an SDIRA transaction?
Disqualified persons include the account holder, spouse, parents, children, certain in-laws, and entities controlled by them. Transactions with these parties can disqualify the IRA.
How does rental income typically get taxed within a Traditional vs. Roth SDIRA?
In a Traditional SDIRA, rental income grows tax-deferred until distributions. In a Roth SDIRA, qualifying withdrawals are tax-free, preserving more after-tax value if rules are followed.
What happens if you live in or rent to family through an SDIRA property?
Living in or renting to close family is considered self-dealing, a prohibited transaction. Such actions can disqualify the account and trigger immediate taxation of the entire IRA.
Why must all expenses and income flow through the SDIRA?
The IRS requires that all property-related income and expenses be handled within the SDIRA. Commingling personal funds risks disqualification and tax penalties.
What role does a custodian play in SDIRA real estate investing?
Custodians hold IRA assets, process transactions, and ensure proper reporting. They don’t provide investment advice but verify compliance with IRS paperwork and titling rules.
How can a checkbook control LLC change SDIRA operations?
A checkbook LLC allows faster property transactions but shifts compliance responsibility to the investor. This raises the risk of errors in valuation, transactions, and IRS reporting.
Why is valuation reporting important in an SDIRA?
Custodians often require annual property valuations for IRS reporting. Without proper updates, the account may face compliance issues and inaccurate tax filings.
What is the biggest compliance pitfall when using SDIRAs for real estate?
The most common pitfall is prohibited transactions such as self-dealing. Even small violations can disqualify the entire IRA, resulting in immediate taxation.
How can SDIRAs provide diversification benefits compared to traditional IRAs?
By holding real estate—residential, commercial, or land—SDIRAs extend diversification beyond stocks and bonds, offering potential rental income and inflation hedging.