Personal Finance

Understanding Self-Directed IRAs: A Look at Some Frequently Asked Questions

Expertise: Personal Finance, Business Management
52 Articles Written

Self-directed IRAs may sound intimidating, but if they’re properly understood and managed, they offer great freedom. Below are some of the most frequently asked questions we receive about self-directed IRAs. Let’s begin with the basics.

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What Is a Self-Directed IRA?

A self-directed IRA account is an IRA that isn’t limited in terms of investment. Funds in these accounts may be invested literally anywhere that is allowed by U.S. law.

The larger institutions that administer most U.S. retirement accounts don’t think it’s a good idea to hold real estate or non-publicly traded assets in retirement plans. This is the primary reason more people do not take advantage of these incredibly useful accounts.

Can I rollover or transfer my existing retirement account to a self-directed IRA?

This depends strongly on your situation, but here are some common examples:

Your Situation: Transfer/Rollover:
I have a 401k or other company plan with a current employer. Not typically. In most instances, your current employer’s plan will make it impossible until you reach retirement age.
I inherited an IRA and keep the account with a brokerage or bank. Yes, you can transfer to a self-directed inherited IRA.
I have a traditional IRA with a bank or brokerage. Yes, you can transfer to a self-directed IRA.
I have a Roth IRA with a bank or brokerage. Yes, you can transfer to a self-directed Roth IRA.
I have a 403b account with a former employer. Yes, you can rollover to a self-directed IRA.
I have a 401k account with a former employer. Yes, you can rollover to a self-directed IRA or Roth IRA, depending on the type of existing account.

 Related: 7 Achievable Steps to Reach 7-Figure Retirement Savings

Where can I invest a self-directed IRA?

Popular types of investments include:

  • Rental real estate
  • Secured loans to others for real estate (trust deed lending)
  • Private small business stock or LLC interests
  • Precious metals, such as gold or silver
  • Cryptocurrency (Bitcoin, etc.)


However, some types of investments are restricted from inclusion in retirement accounts. Examples include:

  • Collectibles, such as fine art, stamps, coins, alcoholic beverages, or antiques
  • Life insurance
  • S corporation stock
  • Any investment owned by someone in your immediate family

What restrictions are there on using a self-directed IRA?

When self-directing your retirement account, you must be aware of the prohibited transaction rules found in IRC 4975. These rules don’t restrict what you can invest in but rather with whom the account can participate in transactions.

The prohibited transaction rules restrict your retirement account from transactions with someone who is disqualified. Disqualified persons include: the account owner, spouses, children, parents, and certain business partners.

On the other hand, you can use your retirement account to buy a rental property from your cousin, friend, sister, or a random third-party person.

Can I invest my self-directed IRA in a personal business, company, or deal?

No. If your IRA transacts with you personally or with a company you own, it violates the prohibited transaction rules.

What is a checkbook-control IRA or IRA LLC?

Many self-directed retirement account owners use an IRA LLC, also known as a “checkbook-control IRA,” to hold their retirement assets so that they have fast access. This is a suitable option for owners with real estate investments.

Can I get a loan to buy real estate with my IRA?

Cash from your IRA can be used to buy real estate, as well as a loan or mortgage. To do this, you must obtain a non-recourse loan.

A non-recourse loan is made by the lender against the asset. In the event of default, the sole recourse of the lender is to foreclose and then seize the asset. The lender cannot pursue the IRA or the IRA owner for any deficiency.

Are there any tax traps?

The Unrelated Business Income Tax (UBIT) applies when your IRA receives unrelated business income. Alternatively, any investment income that your IRA receives is exempt from the UBIT tax.
These types of exempt investment income may include:

  1. Real Estate Rental Income: Rent collected from real estate is investment income and is exempt from UBIT.
  2. Interest Income: Interest and points made from money lending is investment income and is exempt from UBIT.
  3. Capital Gain Income: The sale, exchange, or disposition of assets is investment income and is exempt from UBIT.
  4. Dividend Income: Dividend income from a C corp, where the company pays corporate tax, is exempt investment income.
  5. Royalty Income: Royalty income derived from intangible property rights, such as intellectual property, oil and gas, or mineral-leasing activities is investment income and is exempt from UBIT.

So, make sure your IRA receives investment income as opposed to “business income.”


What is unrelated debt-financed income (UDFI)?

If an IRA is used to buy an investment with debt, then the income attributable to the debt is subject to UBIT. This income is referred to as unrelated debt financed income (UDFI), and it triggers a UBIT. One common instance where this is occurs is a when an IRA buys real estate with a non-recourse loan.

For example, let's say an IRA is used to buy a rental property for $200,000. In this scenario, $100,000 came from the IRA and $100,000 came from a non-recourse loan. The property is now 50 percent leveraged, meaning that 50 percent of the income is not a result of the IRA investment, but rather it's a result of the debt invested. Since debt isn't retirement money, your friends at the IRS will require you to pay tax on 50 percent of the income. So, if there was $10,000 in net rental income on the property, then $5,000 would taxable under UBIT.

Related: The Boring, Plain Vanilla Retirement Strategy with AWESOME RESULTS (No High-Paying Job Needed!)

Should I use an individual 401k instead of a self-directed IRA?

This is where things get interesting, and ultimately, personal.

An individual 401k is a great self-directed account option and can be used instead of an IRA for persons who are self-employed. However, if you aren’t self-employed, the individual 401k may not be the best option for you.

If you are self-employed and you want to maximize your contributions, the individual 401k has much higher maximum-contribution limits: $54,000 annually versus $5,500 annually for an IRA. That’s nearly a 10-fold difference.

And let’s not forget about debt: If you are self-employed and carrying debt, you are much better off choosing an individual 401k over an IRA. Individual 401ks are exempt from UDFI tax on leveraged real estate (mentioned above).


A self-directed IRA is a better option for someone who has already saved for retirement. Some funds can be rolled over and invested in a self-directed IRA.

There are a lot of factors at play when rolling funds into an IRA. Fortunately, you have experts at your fingertips to help determine what type of funding and account considerations your circumstances warrant.

Can’t find the answer to your question here?

Comment below for more information.

Scott Royal Smith is an asset protection attorney and long-time real estate investor. His law firm, Royal Legal Solutions, helps thousands of real esta...
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    Ali Hashemi Investor from Southern Indiana, IN
    Replied about 2 years ago
    Excellent breakdown, thank you for posting. Timing is great for me because I’m in the process of moving a former employer 401k + Roth IRA into a SDIRA in order to use/invest as down payment in my next multi family purchase. Not enough to fund the entire purchase so it looks like I’ll probably have to go the non-recourse loan route to fund the balance. My question is this: In your example 50% of the rental revenue is taxable and 50% is not. The 50% that is not, does that revenue have to go directly into the SDIRA or do I have access to that revenue?
    Cindy Larsen Rental Property Investor from Lakewood, WA
    Replied about 2 years ago
    Great overview Scott. One point about UDFI. In your example where the rental property is 50% leveraged, yes, 50% of the income is potentially subject to UBIT. However, as I understand it (disclaimer, I am not a CPA or financial advisor) that 50% of the income is also able to take advantage of all of the normal rental deductions. So, you get to subtract from that income, 50% of: expenses (property taxes, insurance, repairs and maintenance, capex, etc), mortgage interest, depreciation, etc. Only the remaining taxable income is subject to UBIT. UBIT is taxed at a much higher rate than normal income taxes, so, it would be wise to a) increase deductable expenses by fixing up the property, while b) paying down the mortgage using any income the property produces c) paying down the mortgage using contributions to your retirement fund. In your example, suppose we buy the property using funds from a Self directed Roth IRA that has a balance of $110,000. We put $100,000 down, and borrow $100,000 at 4.5% interest. We pay closing costs with the other $10,000. Our mortgage payments are $507/month, and we rent the house out for $900/month. Suppose expenses are $303/month, leaving us with $90/month of cash flow. So, what would our taxes look like on the $10,800 rental income? First, 50% of that income is generated by the 50% of equity we put down, so it is not taxable, leaving $5,400 of potentially taxable income. From that $5,400 we deduct -$1,818 (50% of our expenses) -$2,233 (50% of the mortgage interest we paid the first year) -$3,636 (50% of the yearly depreciation on $200,000) SO we pay zero UBIT taxes, and carry forward a tax loss. Oh, we also have those points and fees we forgot to deduct that can be carried forward as a tax loss. We keep the $90/month in our Roth as a cash reserve for capex of $1080, and contribute $5,500 to the Roth at the end of the first year. By then, end of the first year, our tenant has paid the mortgage down to $98,387.So we pay $3,387 off the principal, and at the end of the first year only $95,000 of the $200,000 property is leveraged. We have a cash reserve of $3193. During the second year, Since we have less debt, 52.5% ( $105,000/$200,000 = 52.5%) of the income is not taxable, and we do our tax calculation using 47.5% of our income, expenses, interest paid, and depreciation, and we again pay no UBIT. At the end of the second year, we again keep the $90/month cash flow as a reserve in the roth, and contribute $5,500, bringing our cash in the Roth to $9,773 By the end of the 2nd year, the mortgage has been paid down to $93,402.09, so we use part of our cash reserve to pay the principal owed down to $90,000. So, for the 3rd year 55% of the income is not taxable, and our tax calculation is on 45% of the income, expenses, mortgage interest paid, and depreciation. After 2 years we have already jumped ahead to year 5 of our 30 year amortization schedule. At the end of year three we again pay down the mortgage until the principal owed is $85,000. At the end of year four, we folow the same strategy and only owe $80,000, so only $80,000/$200,000 = 40% of our income is potentially subject to UBIT. Continuing this strategy should result in a well maintained rental property that recieves (deductable) minor remodeling/capex improvements every year, as the mortgage is rapidly paid down, and cash reserves are slowly built up in anticipation of large capex improvements needed in the future (new roof in 15 years for example). Eventually, as the rental income increases, repair and maintenance expenses decrease, and mortgage interest paid decreases we might owe UBIT, but it will be on a much smaller fraction of the income, because the amount the property is leveraged will have decreased. Fortunately the depreciation deduction is unchanged for 27.5 years. At some point, it may be worth spending the money to have the property value appraised. It should be worth more because it is now improved, and, if prices have gone up by the historical 4%/year, after 10 years themvalue of the property would be $240,000. If, by then, we only owed $50,000, then the amount of income subject to UBIT would only be 20.8% = $50,000/$240,000. Eventually, that property in your Roth IRA will be paid off, and producing tax free income for the rest of your life. So, if leveraging the purchase of a property by your Roth IRA enables you to make that purchase when you otherwise would not be able to do so, I think it is a good idea, as long as you manage your property to reduce the debt as soon as possible. I plan to use my Roth to purchase a property using leverage within the next year or two, after I convert some additional 401k funds to my Roth IRA.
    Marcin Nurek Rental Property Investor from Crown Point, IN
    Replied about 2 years ago
    A very detailed post Cindy, too bad I can’t upvote like in forums.
    Account Closed from Fredericksburg, Virginia
    Replied about 2 years ago
    Thank you so much for all this information. Love all these details!
    Replied about 2 years ago
    How are you getting around the prohibited transaction rules?
    Joshua Locke Investor from Eagle River, AK
    Replied about 2 years ago
    Thanks for laying out the answers to these frequent questions! I have been looking into using my Roth IRA to buy Real Estate I didn’t realize if I used leverage I would be subject to taxes. I also liked how you contrasted the Roth IRA with individual 401K I had no idea the annual maximums for the 401K were so high! I will have to look into that as my current Roth IRA is somewhat small and I can only add the $5,500 a year to it. The individual 401K opens up new possibilities. Thanks for the article.
    John Murray from Portland, Oregon
    Replied about 2 years ago
    I would like to know how in the event of a short sale how the shorted money is taxed. For tax purposes the shorted amount is usually normal income for that year. The other question is how the passive income or loss is treated. Since the IRS gives the individual investor the $25K pass through of passive loss to other conduits of income it would seem the passive loss or gain must be rolled to the next year or installed in the IRA custodial account. The last is in BRRRR question. Upon refinance the positive funds must be returned to real estate (IRS Tracing Rules). Does the positive funds have to be returned to the custodial account or can the funds be installed in a non custodial account for reinvestment in real estate? Seems un-taxed funds are a very tricky IRS situation.
    Replied about 2 years ago
    Scott: Can I shelter income from real estate rentals in a self directed IRA??
    Harold Rabbie from Los Gatos, California
    Replied about 2 years ago
    What happens when you reach age 70.5 years and become subject to the Required Minimum Distribution (RMD)? With a regular brokerage account, you have to sell (and pay tax on) a specific percentage of the value of the account as of December 31st each year. How does that work if your IRA is invested in real estate?
    Chris Wooten Rental Property Investor from Atlanta, GA
    Replied over 1 year ago
    I hate that no one has answered this yet. You are correct and you still have to honor the RMD. Ideally the property will cashflow enough in the first couple of RMD years to fulfill the requirement. I am not a CPA, but I would look at offering the property up to another investor with owner financing. The cashflow from the owner financing should continue to fulfill the RMD, if structured correctly. Then you no longer have to sustain the property and enjoy retirement while receiving the “note” payments.
    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    Ask and ye shall receive. I apologize, at the time I’d published this article I had not yet set up comment alerts: You do still have to take your RMDs to avoid the penalty. Chris correctly pointed out that the best way to manage this will all come down to your deal structure. Feel free to reach out and let me know your specific concerns, but ideally your passive income should Your tax situation will depend on a variety of factors, including how you’re holding the real estate asset and which structure you’re using (IRA LLC? SDIRA?). There are a variety of tools your professionals can assist you with to minimize real estate tax liabilities–not just in the IRA context, but in general. If it’s a concern for you, it’s certainly worth getting some professional advice from an attorney and/or CPA familiar with your situation.
    Michael Lee Investor from Coppell, TX
    Replied about 2 years ago
    I heard that it is saved from the IRS. Is this true?
    Replied about 2 years ago
    I invested in a syndication deal through my IRA which uses a non-recourse loan (I’m invested in an LLC). I’m assuming that the investment income I get from that will have used all of the deductions allowed, so whatever money I receive in my distribution will be partially taxed. This will be my first investment (and distribution) so it will be interesting to see how it pans out.
    Chris Wooten Rental Property Investor from Atlanta, GA
    Replied over 1 year ago
    I’m not a CPA. If the syndicator is strictly providing you returns based on a preferred share or percentage of buy-in, then the syndicator is holding all of the leverage, and you would not need to concern yourself with UDFI/UBIT.
    Justin Green Real Estate Agent from Portland, Oregon
    Replied about 2 years ago
    I have used this strategy. Self directed IRA with LLC checking account buying cash. I would love to hear about anyone able to pull cash back out to repeat the process vs selling and building the IRA up. How about selling to someone else then back to personal name after 2-3 transfers and property can land in non retirement portfolio? I had a 401k from a previous job I transferred into the self directed IRA.
    Shaun R. from Denham Springs, LA
    Replied about 2 years ago
    Maybe the answer to this is in the article or in these comments and I’m missing it, but does the income you make from the rental property you buy with your SDIRA have to go back into the SDIRA? Or can that income come home to you, whethe it’s taxed or not. So what I want to know is does the rental property I buy with thenSDIRA only go toward padding my retirement account or can I live off that money now?
    Chris Wooten Rental Property Investor from Atlanta, GA
    Replied over 1 year ago
    The income from and SDIRA investment must go back to your SDIRA, otherwise it is considered self-dealing (a PT) Also, for instance, you can’t pay yourself for “property management” on your SDIRA holdings.
    Scott Smith Attorney from Austin, TX
    Replied over 1 year ago
    Shaun, Chris is correct. I’m hoping to publish an article soon addressing common prohibited transactions. This would be considered “self-dealing”–a big no no with our friends at the Department of Labor who regulate these things. The good news is you can use your income from the IRA to fund future investments and continue growing your portfolio. I hope that helps and apologize for the very late reply!
    JL Hut Investor from Greenville, Michigan
    Replied about 2 years ago
    Great topic!
    Matthew Giannascoli from Philadelphia, PA
    Replied about 2 months ago
    Scott, am I reading the above correctly that you are restricted from loaning yourself money to buy a rental property in your individual capacity? Example: I want to buy a property in my individual capacity for 100K and want to put 25K down and finance the remaining 75K via a note from my self-directed IRA. Is this not allowed? If no, can you provide the section of the Code that highlights the restriction? Thanks, Matt