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.

Imagine a retiree named John, who had diligently saved over the years to grow his modest IRA. Instead of adhering to conventional stocks and bonds, John used his Self-Directed IRA to invest in a duplex. Over time, this property not only generated a steady stream of income but also increased in value, offering John a comfortable retirement lifestyle. According to the Investment Company Institute’s latest quarterly release, U.S. retirement assets totaled $43.4 trillion in Q1 2025, with individual retirement accounts (IRAs) at $16.8 trillion in the same period. Many investors assume IRA funds must stay in stocks, bonds, or mutual funds. The reality is that a Self-Directed IRA (SDIRA) allows people to invest in real estate, whether residential, commercial, or rental, if strict IRS rules are followed.

With an SDIRA, you have more say in what you invest in, but you also need to pay close attention to the rules. In this article, you'll learn how to use an SDIRA to invest in real estate, what custodians do, how property income is taxed, and what risks to watch out for.

Key Takeaways

• An SDIRA allows direct ownership of real estate, but all transactions must comply with IRS rules on prohibited transactions and disqualified persons.
• A qualified custodian must hold the account — even though the investor directs the purchases.
• Rental income within an SDIRA is generally tax-deferred (Traditional) or tax-free (Roth), but certain activities can trigger Unrelated Business Income Tax (UBIT).
• All expenses and income from the property must flow through the SDIRA — personal funds cannot be commingled.
• Operational complexity, liquidity challenges, and strict compliance make due diligence essential before committing funds.

Benefits of Real Estate in an SDIRA

Before we get into the rules, let’s look at some of the main benefits:

• Diversification beyond traditional market assets.
• Potential for steady rental income in a tax-advantaged environment.
• Hedge against inflation through tangible asset ownership.
• Control over property type and location, within IRS limits.
• Flexibility to invest in various real estate sectors, including residential, commercial, and land.

1. How SDIRA Real Estate Investing Works

A Self-Directed IRA functions like a traditional IRA in terms of tax advantages, but offers a much broader range of permissible assets, including real estate. The IRS does not explicitly list "real estate" as an allowed investment because almost anything is permitted except life insurance and collectibles. However, it is important to note that certain fringe assets, which some investors might assume are permissible, are not allowed. For instance, collectibles such as art, wine, or vintage cars are excluded. These exclusions are crucial to avoid unintended violations of IRS regulations.

Process overview:

• Open an SDIRA with a qualified custodian.
• Fund it via rollover, transfer, or new contributions (subject to annual limits).
• Direct the custodian to purchase property on behalf of the SDIRA.
• All income and expenses flow through the account, preserving tax status.

The key distinction is that the investor cannot personally hold title to the property — the IRA owns it, and all legal documents must reflect this.

2. IRS Rules and Prohibited Transactions

The most common compliance pitfall is self-dealing — using the IRA’s assets for personal benefit. This includes:

• Living in a property owned by the IRA.
• Renting to family members (spouse, parents, children, certain in-laws).
• Providing sweat equity — personally performing repairs or maintenance.

Violating these rules can disqualify the IRA, triggering immediate taxation and penalties on the entire account.

Disqualified persons under IRS rules include the account holder, their spouse, direct ancestors or descendants, and entities they control. These “self-directed IRA property rules” are non-negotiable.

3. Tax Treatment and Potential UBIT

Within an SDIRA:

• Traditional SDIRA: Property income grows tax-deferred until distributions begin.
• Roth SDIRA: Qualifying withdrawals are tax-free.

But suppose your SDIRA property has a mortgage, or the IRA is involved in business activities like flipping houses. In that case, you might owe Unrelated Business Income Tax (UBIT), even though the account is tax-advantaged. This tax can lower your returns and make taxes more complicated. For example, if a property earns $10,000 and $3,000 of that is from debt, a 37% UBIT rate would mean $1,110 in tax, leaving you with $8,890. It's important to understand how UBIT could affect your profits.

4. Role of the Custodian

Even in a self-directed account, the IRS requires a custodian to hold the IRA assets, process transactions, and report account activity. The custodian does not provide investment advice — they ensure paperwork and titling comply with regulations.

Some investors work with checkbook control LLCs, where the SDIRA owns an LLC that holds a bank account for property transactions. While this adds flexibility, it also increases compliance risk if not properly managed.

5. Operational Considerations

Owning real estate in an SDIRA introduces unique operational requirements:

• All expenses — repairs, property taxes, insurance — must be paid from the SDIRA.
• All income — rent payments, sale proceeds — must be deposited into the SDIRA.
• Liquidity is limited — selling property to fund distributions can take time.
• Valuation reporting — custodians often require annual valuation updates for IRS reporting.

Hypothetical: An investor buys a $200,000 rental property in an SDIRA. The tenant pays $1,500/month in rent, which is deposited directly into the IRA. A $5,000 roof repair arises — this must be paid from the IRA’s cash balance, not personal funds.

Risks and Common Pitfalls

Even experienced investors can run into trouble when using an SDIRA for property ownership:

• Prohibited transactions that trigger disqualification.
• Liquidity constraints when cash is tied up in property.
• Unexpected UBIT liability from leveraged investments.
• Maintenance and expense timing — insufficient IRA cash flow can lead to compliance issues.

The bottom line is that understanding the rules is just as important as picking the right property.

In summary, using an SDIRA to invest in real estate can help you diversify your retirement savings and get tax benefits. But because the rules are complex, even small mistakes can have serious results. The best investors make sure to follow IRS rules closely, treating them as a key part of the investment process.