At a glance
- What it is
- An IRA held with a custodian that allows alternative investments such as rental property, private loans, and private companies.
- What it saves
- Tax on the investment’s income and gains: deferred in a traditional IRA, tax-free in a Roth if the Roth rules are met.
- Best fit
- Investors who know an asset class well.
- Main catch
- Strict prohibited-transaction rules. No personal use and no deals with yourself or close family.
- Penalty for a mistake
- A prohibited transaction can disqualify the entire IRA.
Key takeaways
- A self-directed IRA uses a custodian that allows alternative investments, so your IRA can own rental property, private loans, and private deals.
- It fits investors who know an asset class well and have enough cash inside the IRA to cover vacancies and repairs.
- In the illustrative example, a Roth IRA’s $150,000 rental nets $9,000 a year, with no tax on it if Roth rules are met.
- The catch: one prohibited transaction, such as personal use or a deal with close family, can disqualify the entire IRA.
The numbers
Picture an investor whose self-directed Roth IRA buys a $150,000 rental house with cash. It rents for $1,200 a month, and the IRA pays all expenses.
For illustration purposes. Tax law may change, which may change these calculations slightly.
| Rent: $1,200 × 12 | $14,400 |
| Property tax, insurance, repairs, and management, paid by the IRA | −$5,400 |
| Net rental profit, kept inside the Roth IRA | $9,000 |
Personal tax on that $9,000 (federal and Oklahoma)
| Owned personally | Inside a Roth IRA | |
|---|---|---|
| Depreciation: $120,000 building value ÷ 27.5 years | about $4,364 | Not available |
| Taxable rental income | about $4,636 | $0 |
| Federal income tax (24% bracket) | about $1,113 | $0 |
| Oklahoma income tax (4.5%) | about $209 | $0 |
Inside the Roth, the profit and any gain when the house is sold are never taxed, as long as withdrawals meet the Roth rules. The tradeoff: the IRA gets no depreciation deduction, the money can’t come out early without tax consequences, and you can’t use the property yourself. In a traditional IRA, the profit is deferred and taxed as ordinary income when it’s withdrawn.
Every dollar has to stay inside the IRA. Rent goes to the IRA, the IRA pays every expense, and you can’t pay a repair bill out of pocket or fix the roof yourself.
Could this strategy work for your business?
In a free tax analysis, your tax strategist checks whether it fits and what it could save, using your real numbers.
How it works
- Open a self-directed IRA. Choose a custodian that holds alternative assets, and move money in by a direct transfer or rollover from another IRA or old 401(k).
- Find the investment. You pick it; the custodian doesn’t give advice or vet the deal.
- The IRA buys it. Title is held in the IRA’s name, and the custodian signs and pays from the IRA.
- Run everything through the IRA. Income goes in, expenses go out, and the custodian reports the asset’s value each year.
Who it fits
- Investors who know an asset class well, such as local rentals, private lending, or a specific industry.
- People with sizable IRA or old 401(k) balances who want to diversify beyond the stock market.
- Investors with enough cash inside the IRA to cover vacancies and repairs.
When it doesn’t fit
- Anyone who wants to use the property, rent it to family, or invest in their own business.
- Investors who would rely on depreciation or rental losses to offset other income; those don’t pass through from an IRA.
- People who may need the money before retirement.
The rules
- Prohibited transactions. The IRA can’t buy from, sell to, lend to, or benefit you, your spouse, your parents and grandparents, your children and grandchildren and their spouses, or businesses you control (IRC §4975).
- No personal benefit. No personal use of the property and no “sweat equity”; you can’t do the work yourself.
- Debt brings tax. If the IRA borrows to buy property, the share of income from the borrowed money can be taxed inside the IRA as unrelated business taxable income.
- Collectibles and life insurance aren’t allowed IRA investments.
Risks to weigh
- Losing the IRA. A prohibited transaction generally treats the entire IRA as distributed as of January 1 of that year: taxable, and possibly penalized if you’re under 59½.
- Illiquidity. Required distributions from a traditional IRA still have to be taken, even if the money is tied up in a house.
- Fraud and fees. Custodians don’t vet investments, and fees are higher than at a typical brokerage.
- Valuation. Hard-to-value assets have to be valued each year for reporting.
How we handle it for clients
With a Cannon & Brown tax plan, we review the deal for prohibited-transaction and debt-financing issues before you commit, help you decide between a traditional and Roth account, and keep the IRA’s activity separate from your personal and business returns. Because our technology keeps your numbers current all year, we can test this strategy against your real numbers and adjust it as your business changes.
Illustrative example. The investor and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes a cash purchase with no debt, $120,000 of the price allocated to the building, a full year of residential depreciation, a 24% federal bracket, and a 4.5% Oklahoma rate. This page is educational and is not tax or investment advice for your situation; tax rules and limits change.
Brooks leads Cannon & Brown Tax Advisors, a forward-thinking tax firm serving business owners in Oklahoma and beyond. He builds year-round tax strategies that help business owners keep more of what they earn and reach their goals. More about Brooks
Common questions about the self-directed IRA
Can I buy a rental property with my IRA?
Yes, with a self-directed custodian. Title is held in the IRA’s name, the IRA pays every expense, and all rent goes back into the IRA.
Can I do repairs on my IRA’s rental property myself?
No. The rules allow no personal benefit and no sweat equity, so you can’t do the work yourself or pay a repair bill out of pocket.
Can my IRA take out a loan to buy property?
It can, but if the IRA borrows to buy property, the share of income from the borrowed money can be taxed inside the IRA as unrelated business taxable income.
Can my self-directed IRA invest in my own business?
No. The IRA can’t buy from, sell to, lend to, or benefit you, close family members, or businesses you control. That makes investing in your own business one of the situations where a self-directed IRA doesn’t fit.
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