Self-Directed IRAs
for Real Estate

The basic structure

An SDIRA is a standard IRA with a custodian that permits alternative assets — real estate, private lending, tax liens, precious metals, closely held LLC interests. Mainstream brokerages (Fidelity, Vanguard, Schwab) do not offer self-directed custody for alternatives. You need a specialized custodian.

Major SDIRA custodians:

• Equity Trust Company
• Entrust Group
• Quest Trust Company
• Directed IRA (formerly KKOS Lawyers)
• IRA Services Trust / PENSCO
• Midland Trust
• Advanta IRA

The IRA holds title to the property — not the individual. Deed reads “Equity Trust Company Custodian FBO [Your Name] IRA.” All income flows back to the IRA; all expenses are paid from the IRA. The account holder never directly touches the money.

Contribution limits and rollovers

SDIRAs follow standard IRA contribution limits:

• 2024/2025 IRA: $7,000 ($8,000 age 50+)
• SEP-IRA: up to 25% of compensation or $69,000 (2024), whichever is less
• Solo 401k (alternative structure): up to $69,000 combined employee/employer

Most SDIRA real estate purchases are funded by rollovers— transferring an existing 401k, Traditional IRA, or Roth IRA balance into the SDIRA. A direct rollover isn’t a taxable event. $300,000 in a 401k from a prior employer rolled to an SDIRA is $300,000 of real-estate-buying power.

Prohibited transactions (§4975)

This is where SDIRAs destroy themselves. IRC §4975 prohibits transactions between an IRA and disqualified persons:

• The IRA account holder
• Account holder’s spouse
• Lineal ancestors and descendants (parents, grandparents, children, grandchildren) and their spouses
• Fiduciaries (e.g., the account holder acting as sole member of IRA-owned LLC)
• Any entity 50%+ owned by any of the above

Common prohibited transaction scenarios:

• Living in a property owned by your own IRA, even one night
• Renting an IRA-owned property to your parent or child
• Having your son do the renovations on an IRA property (even if paid fair market value)
• Personally paying property expenses from your checking account (instead of from the IRA)
• Receiving property management fees from your IRA
• IRA lending to an LLC you own 50%+
• Guaranteeing a loan for an IRA-owned property

Consequence of a prohibited transaction: the entire IRA is deemed distributed as of January 1 of the year the prohibited transaction occurred. The account holder owes income tax on the full account balance (plus 10% early withdrawal penalty if under 59½) plus loss of all future tax-deferred growth. A $500,000 Roth SDIRA can become a $175,000 after-tax event overnight.

UBTI and UDFI on leveraged real estate

Here’s the tax trap most SDIRA beginners miss. Unrelated Debt-Financed Income (UDFI) under IRC §514 imposes tax on the debt-financed portion of IRA income. Even though the IRA is supposedly tax-deferred, when the IRA uses leverage, the interest, principal, depreciation, and eventual gain are proportionally taxed at trust rates — which reach 37% at just $14,450 of income.

Example. SDIRA puts $60,000 down on a $200,000 rental using a $140,000 non-recourse loan. 70% of the property is debt-financed. Each year:

• Net rental income after expenses and depreciation: $6,000
• UDFI portion: 70% × $6,000 = $4,200
• Less $1,000 specific exemption = $3,200 UBTI
• Tax at trust rates: approximately $600–$1,000

At sale, UDFI continues to apply to the debt-financed portion of the capital gain. A $50,000 gain on a 70%-leveraged property generates $35,000 of UBTI — taxed at trust rates around 37% = $13,000 of tax on a supposedly tax-deferred transaction.

Non-recourse financing is mandatory for SDIRA real estate — personal guarantees are prohibited transactions. A handful of lenders specialize in non-recourse IRA loans: North American Savings Bank, Pacific Premier Bank, First Western Federal Savings, Solera National Bank, among others.

Solo 401k — the UDFI escape

Solo 401k plans (for self-employed with no non-spouse employees) receive a statutory exemption from UDFI on real estate debt. A Solo 401k can use leverage on real estate without the UBTI consequences that plague SDIRAs.

Solo 401ks also allow higher contribution limits ($69,000+ combined in 2024 vs. $7,000 for an IRA) and loan provisions ($50,000 or 50% of balance), and they can hold the same alternative assets as SDIRAs (real estate, private lending, etc.).

Qualification: any self-employment income qualifies — consulting, W-2 side gigs, flipping property. Many investors specifically set up a consulting LLC to generate the self-employment income needed to establish a Solo 401k that then funds their real estate investments.

Checkbook IRA LLC

A checkbook IRA is an LLC owned 100% by the IRA, with the account holder as manager (unpaid). The LLC holds the real estate; the account holder can write checks from the LLC’s bank account to pay property expenses and collect rent directly into the LLC account, without routing every transaction through the custodian.

The structure was validated in Swanson v. Commissioner (T.C. 1996) and has been widely used since. It dramatically reduces custodian transaction fees ($50–250 per transaction with some custodians) and accelerates time-sensitive decisions.

Compliance remains strict: the IRA holder cannot take salary as manager, cannot use the LLC’s account for personal expenses, cannot direct the LLC to transact with disqualified persons. The IRS continues to scrutinize checkbook IRAs aggressively, particularly for self- dealing hiding inside the LLC.

Roth conversion strategy

Traditional SDIRA gains are tax-deferred; Roth SDIRA gains are tax-free. For long-horizon real estate investors, Roth is dramatically more valuable — particularly if the real estate is expected to appreciate significantly.

Converting Traditional to Roth triggers current-year income tax on the converted amount. Professional SDIRA investors time conversions with low-income years or down-market years when the IRA balance is temporarily depressed (reducing conversion tax cost).

Common pitfalls

• Prohibited transaction via family member. Renting to your son, having your mother manage maintenance, lending to your spouse’s business — all blow the account. Keep all transactions arm’s-length with unrelated parties.
• Self-dealing. Pay yourself property management, live in the property overnight, store personal items on-premises. All prohibited. The IRS considers these alter-ego violations.
• UBIT surprise. Debt-financed real estate generates UBTI. Budget for Form 990-T filing and the resulting tax. Many SDIRA investors never file Form 990-T until the IRS catches up — then owe multiple years of back taxes with penalties.
• Insufficient IRA cash. Property repair needed, HVAC breaks, vacancy extends. If the IRA runs out of cash, the account holder cannot personally pay property expenses — that’s a prohibited transaction. Maintain 6–12 months of operating reserves inside the IRA.
• Custodian fees. Annual custodian fees ($300–600), transaction fees ($50–250 per), asset holding fees on real estate ($100–400/year per property). Fees can run $2,000–5,000/year on a small portfolio; checkbook IRA structure reduces them.
• Missing required minimum distributions (RMDs). Traditional IRA holders 73+ must take RMDs. Illiquid real estate in an SDIRA can create forced sales or in-kind distributions that are themselves taxable. Plan liquidity at age 70.
• Personal guarantees (recourse financing). A personal guarantee on an IRA loan is a prohibited transaction. Only non-recourse financing is permitted. Many beginner SDIRA investors try to use standard investor loans — instant violation.
• Flipping with an IRA. Frequent flipping inside an IRA can trigger Unrelated Business Income (UBI, separate from UDFI). If the flipping is considered a trade or business, all income is taxable as UBI at trust rates.