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What are Self-Directed IRAs? (And How To Invest In Real Estate With One)

Glass Piggy Bank with House and Money Inside

When I started my MBA accounting class, it seemed like an easy A. I mean, it's only arithmetic! But, I quickly became overwhelmed by all the terms: debits, credits, accounts payable/receivable, accrued expense, gross profit, journal entries, and more. It turns out that accounting is like learning a foreign language. It feels familiar - and therefore seems like it should be easy to understand - but it's just different enough that it requires focus and gets confusing fast.

All that to say: self-directed IRAs are genuinely confusing. They're absolutely worth learning about, but you're not alone if you still don't get it. My goal is to give you enough details that a) you can talk about them intelligently and b) you'll feel confident about setting one up.

Let's do this.

TL;DR Summary of Self-Directed Individual Retirement Accounts (SDIRA)

  • An SDIRA is a retirement account that lets you invest in alternative investments like real estate and businesses. Almost anything, but the restrictions are important to know.
  • If you have a 401(k) from a previous employer, you can transfer it into an SDIRA.
  • Like all retirement accounts, the gains are either tax-deferred or tax-free. Woohoo!
  • There is a UBIT tax if you invest in syndications, but it can be offset by depreciation if there's a mortgage on the property. Talk to your tax or financial advisor about this.
  • You, or your family, cannot benefit from the investment. i.e., You can't rent to your family or manage it yourself. If you're unsure, talk to your tax or financial advisor (you should probably do it no matter what).

What Is a Self-Directed Individual Retirement Account (SDIRA)?

The difference between an IRA and 401(k) offered by an employer versus a Self-directed IRA is that - as the name implies - you control what the IRA invests in. You're no longer limited to stocks, bonds, and mutual funds. You're almost unlimited in what you can invest in as long as it's allowed by the IRS and you follow specific rules on handling the money. And the gains are still tax-deferred, like a traditional retirement account.

The IRS requires that a qualified custodian holds the IRA's assets on your behalf. You decide where it invests, and the custodian manages the transactions, records, filing IRS reports, and administrative duties. It's not free, but no custodian is.

Where You Can Invest a Self-Directed IRA

The list of what you can't invest in might be shorter. That's the massive benefit of SDIRAs. Yes, it takes more education because you're now responsible, but the rewards are worth it. Not only can you achieve true diversification, but you can invest in companies that offer the potential for a high ROI.

Here's a partial list of the main categories:

  • Real Estate: commercial, shopping centers, office parks, duplexes, raw land, apartments, single-family residences, tax liens, and REITs
  • Promissory Notes: mortgages and unsecured notes
  • Private Placements: LLCs, limited partnerships, startups, hedge funds, small businesses, equity crowdfunding, and land trusts
  • Commodities: gold and silver, oil, gas, lumber, and minerals

This means that you can invest in real estate syndications with us! :)

We form a new LLC for each multifamily apartment and sell equity using a private placement memorandum. So, you're SDIRA can own part of the multifamily apartment.

Restrictions On Using a Self-Directed IRA

Let's talk about that shorter list. You DO NOT want to break these rules because there are severe tax consequences. Always consult your tax or financial advisor if you're unsure of a transaction or situation.

  • Disqualified Persons: These people cannot make any direct or indirect investments/transactions with the SDIRA. They include you, any account beneficiaries, family members (spouse, parents, grandparents, kids, and their spouses, grandchildren, etc.), or an entity owned by 50% or more by a disqualified person. Basically, anyone close to you cannot benefit from it. So, you can't buy a rental through your SDIRA and live in it, rent it to your kids, or manage it yourself.
  • Personal Benefit: You can't use it for your personal benefit. That means you can't buy a rental and deposit the rent checks into your personal account. You must deposit all income into the SDIRA account. Think of an SDIRA as a 3rd-party person who owns the investment.
  • Disallowed Investments: collectibles (art, antiques, gems, stamps, etc.), life insurance, S-corporations, and illegal activities
  • Prohibited Transactions: Sell/exchange/lease property your already own into your SDIRA, transfer/lend SDIRA income/assets to a disqualified person, or supply goods, services, and facilities to a disqualified person.
  • Retirement Age: Like traditional IRAs, you can't start withdrawing funds until you're 59 1/2.

There are some subtleties and fine print to all of these. So again, consult your tax or financial advisor if you're unsure of a transaction or situation.

Truly Self-Directed IRAs = Checkbook Control

Ready for a little more confusion? There are different levels of "self-directed." Some companies use "self-directed" as a marketing term only: you can direct which stocks, bonds, or mutual funds to invest in only. Umm... No.

Others allow for alternative investments, but you must submit documentation for each investment transaction/transfer to the IRA custodian for their review and approval. This can take 2-3+ days, and they usually charge a fee. That's better, but still not great.

Instead, you want checkbook control. It allows you to invest, divest, and manage any qualified investment at any time. There isn't a literal checkbook, but if you want the true freedom to control how you invest your retirement assets, you need this feature. Slightly more technical details: business trusts and self-directed IRA LLCs are two entities that give you full checkbook control. For the trust, you're a trustee, and for the LLC, you're the manager.

Can I Transfer My Existing Retirement Account Into a Self-Directed IRA?

Let's get the bad news out of the way: 401(k)s cannot be used in real estate transactions and can't be transferred to an SDIRA. But as soon as you leave a company, that 401(k) retirement account magically becomes an IRA. Which means it can now be transferred into an SDIRA.

To be clear on what can be transferred:

  • Traditional IRA: Yes, to a Self-Directed IRA.
  • Roth IRA: Yes, to a Roth Self-Directed IRA with the same after-tax benefits.
  • 403b with a former employer: yes, depending on the type, it can be traditional or a Roth.

And, just like all IRAs, you can continue contributing to your SDIRA. The current maximum amount changes yearly. So, here are the current IRS contribution limits.

Advantages of Using a Self-Directed IRA to Buy Real Estate

Tax-Free or Tax-Deferred Growth

Like other IRAs, traditional IRAs are only taxed when you withdraw the funds. This is huge! You can roll 100% of the profits of an investment into the next project. Since you don't pay taxes immediately, that allows for massive compounding! Plus, apartment syndications average 10% - 15% annual returns. The returns add up exponentially.

If you invest $100,000 at 10% and keep reinvesting for 30 years, you'd have $436,235. Not bad!

And if you're using a Roth SDIRA, taxes are never paid!

If you have a 401(k) from an old employer, it's technically now an IRA. That means it's eligible to be transferred to an SDIRA. This is a massive opportunity for you for future growth.

Safe and Sheltered

In the same way that it's hard for you to get money out of your SDIRA, it's hard for others - like creditors and judgments - to get money out too. It's usually safe from bankruptcy and hard to sue because it's technically a trust account. Again, think of it as a 3rd-party person; it's not you. It would be like going after your friend for money you owe. Obviously, you hope this benefit never matters, but it's nice to know it's there.

Your Control

With Checkbook control, you can use your knowledge to invest in ways that support your goals or improve your chances of success.

True Diversification

Billionaires diversify their wealth with 3 buckets, and only one bucket includes stocks & bonds. The other bucket is cash-flowing commercial real estate, and the final bucket is direct investments. Read more about the diversification strategy the ultra-wealthy use.

Pitfalls of Using a Self-Directed IRA

SDIRAs aren't perfect. Here are some gotchas to be aware of.

Loss of Deprecation Benefit

According to SDIRA rules, you lose the benefits of depreciation. Lame, I know. But keep reading because that's not totally true with apartment syndications that use debt financing.

If your head isn't hurting yet, just wait.

Unrelated Business Income Tax (UBIT)

UBIT applies when your SDIRA receives unrelated business income. More specifically to apartment syndications, it's the Unrelated Debt Financed Income (UDFI) tax. On SDIRAs, there's a tax on the percent of gains attributed to debt financing. So, if your SDIRA invests in a property acquired with 70% debt financing, 70% of the gains will be taxed.

But there's hope! Remember above how you don't get the depreciation benefit? Guess what? Depreciation and other operating expense deductions are allowed when using debt financing. This usually results in no taxable income during the hold period. Only when the property is sold are gains realized.

There's some complicated math to figure out the actual impact, but generally, you can assume a reduction of 1-2% on your syndication's return if you invest using an SDIRA. It's still less than paying income taxes, so it's a net positive.

There's more to the definition of a UBIT, but it's not as relevant to syndications. If you're not doing syndications, ensure your SDIRA receives "investment income" instead of "business income" to be exempt from the UBIT tax. Exempt incomes include rental income, interest income, capital gains income, dividend income, and royalty income. This is another "talk to your tax or financial advisor" situation.

Fees & Paperwork

No surprise here. There's additional paperwork to file to track your investments. And each custodian charges a fee. Some are better than others. I would focus more on access to your funds, but you do want to pay attention to fees.

Heavily Regulated and Complicated

All retirement accounts are heavily regulated by the SEC. The big thing that the SEC looks for is restricted uses. Are you, or another disqualified person, benefiting? If you break a rule, your entire account will be disqualified.

Fun fact: you can hold multiple SDIRAs (by splitting up a larger one or by not combining existing IRAs). That will limit your liability, but you'll want to weigh that against the extra cost and complexity.

How To Set Up a Self-Directed IRA

We're in the home stretch, and this part should be easy.

  1. Open an account from a qualified custodian (see below).
  2. Fund your SDIRA by rolling over an existing IRA. If you're starting from scratch, consider opening a ROTH SDIRA.
  3. Direct your custodian to invest your SDIRA's funds via checkbook control. Each custodian will tell you how to do it using their system.
  4. Receive income and gains from your SDIRA's investments.
  5. Enjoy gains from a diverse set of assets.

Companies That Offer Self-Directed IRAs

There are many to choose from, but the #1 recommendation from multiple places for real estate investing is uDirect IRA Services. There are other companies, like American Estate & TrustCheck Book IRA, and Safeguard Advisors, but uDirect is most people's choice if they're focusing on real estate.

Next Steps

Whew! That was a ton of information. The general concept is straightforward: it's a retirement account that lets you invest in alternative assets. But there are some considerable tax benefits, but a few tax gotchas to be aware of. And finally, you don't want to invest with a disqualified person.

If you have a 401(k) from a previous employer or an IRA with a traditional broker, you could start passively investing in apartment syndications sooner than you think. This is a great way to accelerate your wealth from one of the best investments on the planet.

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Let's build your wealth and improve housing, together

Passive Income

Tenants pay monthly rent, which covers expenses and generates a profit for investors. Plus, multifamilies appreciate and usually sell for a significant profit.

Consistent Above-Average Returns

Real estate is less volatile and historically outperformed the S&P 500 by routinely generating average annual returns of at least 10% after fees, inflation, and taxes.

Revitalize Local Communities

We give people a great, safe place to call home. This doesn’t hit the spreadsheet, but every property is managed and maintained with the residents as a top priority.

Extraordinary Tax Benefits

Your income is taxed much lower because of depreciation and because it’s taxed at a lower capital gains rate.

Below-Average Risk

More units mean less vacancy sensitivity. Plus, costs are distributed across a larger number of units, which also allows us to hire a professional property manager.


Unlike stocks, lenders like to finance multifamilies and the loans are tied to the property, not the person. This accelerates wealth building.