A self-directed IRA (SDIRA) is an individual retirement account held at a custodian that permits alternative assets — private placements, real estate, promissory notes, private funds — rather than only the stocks, bonds, and mutual funds available at mainstream brokerages. The tax rules are the same as any IRA; what differs is the custodian’s willingness to hold nontraditional assets.
How self-directed IRAs work
Nothing in the tax code restricts IRAs to public securities. The code prohibits only a short list — life insurance and collectibles (and S corporation stock is incompatible for entity reasons) — leaving real estate, private equity, private credit, private placements, precious metals meeting purity standards, and more as permissible. The constraint in practice is custodial: every IRA must have a trustee or custodian, and mainstream firms decline assets they can’t price or process. A specialized custodian industry exists to fill the gap, handling the paperwork, custody, and annual fair-market-value reporting that nontraditional assets require.
Contribution limits, distribution rules, and required minimum distributions all follow normal IRA rules, in either traditional (tax-deferred) or Roth (tax-free growth) form. Investors typically fund SDIRAs by transfer or rollover from existing retirement accounts, since annual contribution limits are small relative to alternative-investment minimums. Fees run higher than brokerage IRAs — account fees, per-asset fees, transaction charges — and belong in any cost comparison.
The rules that actually bite
Two bodies of rules create most SDIRA problems, and both are unforgiving.
Prohibited transactions. An IRA cannot transact with “disqualified persons” — the owner, spouse, ancestors, descendants, their spouses, and entities they control. That means no buying property from yourself, no renting the IRA’s condo to your daughter, no personally guaranteeing the IRA’s loan, no fixing the IRA’s rental with your own labor, no paying yourself for managing it. The penalty is structural: a prohibited transaction can disqualify the entire IRA as of January 1 of the year it occurs, triggering a deemed distribution of the full account — tax and potentially penalties on everything, not just the offending asset. “Checkbook control” LLC structures, marketed for transactional convenience, concentrate exactly this risk by removing the custodian from the transaction path.
UBTI and UDFI. Tax-exempt accounts pay tax on unrelated business income, and IRAs are no exception. Operating businesses held through partnerships and — the common surprise — income from debt-financed property (UDFI) can generate current tax inside the IRA, filed on Form 990-T at compressed trust rates. A leveraged real estate fund issuing a Schedule K-1 is the classic trigger. REIT dividends, by contrast, are generally not UBTI, which is one structural reason non-traded REITs, BDCs, and interval funds fit retirement accounts more cleanly than leveraged partnerships.
Diligence deserves a final word: regulators have repeatedly warned that fraud promoters favor SDIRAs precisely because custodians for self-directed accounts do not vet investments — “custodied” is not “endorsed,” and the account owner (with their advisor) bears the entire evaluation burden.
FAQ
What is a self-directed IRA in simple terms?
A normal IRA at a custodian that allows alternative assets. Same tax treatment, same contribution limits — different investable universe and more responsibility on the owner.
How do you set up a self-directed IRA?
Open an account with a specialized custodian, fund it by transfer or rollover, then direct the custodian to make the investment — subscription documents for a fund, or purchase documents titled in the IRA’s name for direct assets.
Can I buy real estate in a self-directed IRA?
Yes, but the property must be a pure investment: no personal or family use, all expenses paid from the IRA, all income returned to it, and any mortgage non-recourse — which also raises the UDFI tax issue.
What can't a self-directed IRA invest in?
Life insurance and collectibles are prohibited by statute, and S corporation shares don’t work. The bigger practical exclusion is any transaction touching you, your family, or your businesses.
Related terms
UBTI · Schedule K-1 · Non-Traded REIT · Private Placement · Accredited Investor
Educational content only; not investment, tax, or legal advice. Consult qualified professionals regarding your specific circumstances.
