Adam Bergman

Founder, Tax Lawyer, Author

Real estate is one of the most popular assets in a Self-Directed IRA. It’s also where I see investors make the most expensive mistakes. A rental property feels personal in a way a stock never does. You want to fix the leaky faucet, rent to your kid, or chip in a few thousand dollars from savings when a roof needs replacing. In a Self-Directed IRA, each of those moves can be a prohibited transaction. The penalty isn’t a fine. The IRS can treat your entire IRA as distributed. The rules aren’t complicated once you understand the principle behind them: the IRA owns the property, and you don’t get to benefit from it personally until you take a distribution.

What Is a Prohibited Transaction?

Internal Revenue Code Section 4975 bars certain transactions between your retirement account and a “disqualified person.” According to the IRS, that includes any improper use of the IRA by the account owner, a beneficiary, or a disqualified person. For real estate, this covers:

• Selling, exchanging, or leasing property between the IRA and a disqualified person
• Lending money or extending credit between them
• Furnishing goods, services, or facilities
• Transferring IRA income or assets to, or using them for the benefit of, a disqualified person

Who Is a Disqualified Person?

The disqualified person rules are the foundation of everything else. Disqualified persons include:

• You, the IRA owner
• Your spouse
• Your ancestors, such as parents and grandparents
• Your lineal descendants, such as children and grandchildren, and their spouses
• Fiduciaries and anyone providing services to the IRA
• Any entity where disqualified persons own 50% or more
• Officers, directors, 10% owners, and highly compensated employees of those entities

Siblings, aunts, uncles, and cousins aren’t on the list. A deal with them can still be a problem if it indirectly benefits you or another disqualified person.

What Happens if You Break the Rules

If you, as the IRA owner, engage in a prohibited transaction, the IRA stops being an IRA as of January 1 of the year the transaction happened. The entire fair market value is treated as distributed. That amount is taxed as ordinary income, and if you’re under 59½, a 10% early withdrawal penalty generally applies too. If another disqualified person is involved, that person can also face excise taxes under Section 4975.

One mistake on one property can blow up the tax treatment of the whole account. That’s why these rules deserve your attention before you buy, not after.

Six Rules to Keep Your Real Estate IRA Compliant

1. Use only IRA funds. The purchase price, closing costs, property taxes, insurance, repairs, and HOA dues all come from the IRA. Rental income goes back to the IRA. Paying a bill personally, even once and even to help out, is a prohibited transaction. Keep a cash reserve inside the IRA, such as three to six months of expenses, so you’re never tempted.
2. Title the property in the IRA’s name. The deed should read in the name of the IRA, for example “IRA Financial Trust Company FBO [your name] IRA,” or in the name of the IRA-owned LLC if you use a Checkbook IRA. Title in your personal name is a red flag.
3. No sweat equity. You and other disqualified persons can’t do renovations, repairs, or property management, even unpaid. As manager of your Checkbook IRA LLC, you can make decisions, sign leases, and pay bills from the IRA account. The physical work goes to an unrelated third party paid by the IRA.
4. No personal use or related-party tenants. You can’t live in the property, vacation in it, or use it as an office. You can’t rent it to your children or parents, even at fair market rent. You also can’t buy property from or sell property to a disqualified person.
5. Non-recourse financing only. If the IRA borrows to buy property, the loan has to be non-recourse, so the lender can look only to the property if the loan defaults. You can’t personally guarantee the loan. Also, the portion of income and gains tied to the debt is subject to unrelated debt-financed income (UDFI) tax, a form of UBTI. A Solo 401(k) is generally exempt from UDFI on real estate loans, which is one reason some self-employed investors prefer it for leveraged deals.
6. Keep the IRA’s money separate. Don’t lend IRA funds to yourself or a family member, and don’t pledge the IRA as collateral for a personal loan. Rental income and sale proceeds stay in the IRA until you take a reportable distribution.

A Real-Life Example

Say your Self-Directed IRA buys a property for $100,000 and later sells it for $300,000. The $200,000 gain stays in the account, and you don’t pay tax on it in the year of the sale.

• In a Roth IRA, you can withdraw that gain tax free if the Roth has been open at least five years and you’re 59½ or older.
• In a Traditional IRA, the gain grows tax deferred and is taxed as ordinary income when you take distributions.

Either way, the result depends on following every rule above for the entire time the IRA owns the property. If you break the rules once, the gain and the rest of the account are treated as distributed.

What the Courts Have Said

Court cases show how closely the IRS and judges look at personal benefit. You can read more in my summary of the important prohibited transaction cases.

• Peek v. Commissioner (2013). The taxpayers personally guaranteed a loan tied to a business owned by their IRAs. The Tax Court ruled that the guarantees were prohibited extensions of credit, and the IRAs lost their tax-advantaged status. Thiessen v. Commissioner (2016) reached the same result on similar facts.
• In re Kellerman (2015). An IRA bought land in partnership with an entity the IRA owner controlled, which planned to develop the land. The bankruptcy court found self-dealing because the IRA was used to benefit a disqualified person’s business.
• In re Cherwenka (2016). A Georgia bankruptcy court ruled that an IRA owner who chose and oversaw house flips for his IRA hadn’t engaged in a prohibited transaction, because he received no personal payments or benefit. I wouldn’t treat this as a green light. It’s one bankruptcy ruling, and the safer path is still to keep all hands-on work with unrelated third parties.

Other Things to Know Before You Buy

• Choose the right custodian. Many large brokerages don’t allow real estate in an IRA. You need a Self-Directed IRA custodian that does. At IRA Financial, we charge a flat annual fee, so your costs don’t climb as your real estate holdings grow.
• Know the tradeoffs. You can’t deduct depreciation or mortgage interest on your personal return for property your IRA owns. Real estate is also illiquid, which matters when required minimum distributions start on a Traditional IRA.
• Keep good records. Document every transaction, keep IRA and personal accounts fully separate, and track the property’s value. Your custodian needs a year-end fair market value for Form 5498.

Final Thoughts

I’ve worked with real estate investors in Self-Directed IRAs for well over a decade, and nearly every prohibited transaction problem I see comes from treating the property as personal. Keep the IRA’s money, property, and benefits separate from your own. Use unrelated third parties for the hands-on work, and get a second opinion before any deal that involves family. Real estate can be a great fit for retirement savings if you set it up correctly from the start.

This content is for educational purposes only and does not constitute legal, tax, or investment advice. Consult a qualified professional before making any investment decisions.