MECHANICS 07
RETIREMENT ACCOUNTS
AND REAL ESTATE.
Some people hold real estate or notes inside a self-directed retirement account. The concept is simple. The rules around it are not, and the penalties for getting them wrong are severe.
This page is a high-level explanation only. It is not tax advice, not legal advice, and not a recommendation. These are questions for your CPA, your attorney and a qualified custodian.
What self-directed means
A self-directed retirement account is not a different type of account under the tax code. It is the same kind of account held at a custodian whose platform permits assets beyond publicly traded securities.
A conventional brokerage offers what it offers. A self-directed custodian administers accounts that may hold a wider range of assets, which in some cases includes real property and notes secured by real property. The account owner directs what the account acquires, within the rules.
The word self-directed causes most of the confusion. It refers to who chooses the asset. It does not mean the rules are relaxed, and it does not mean the custodian has reviewed anything for suitability. Custodians administer. They do not vet.
The custodian's role, and what it is not
A custodian holds the assets in the account's name, processes transactions the owner directs, handles required reporting, and maintains records.
What a custodian generally does not do is evaluate whether an asset is a good idea, verify that a valuation is accurate, confirm that an operator is legitimate, or tell you that a transaction you have directed will create a problem. Many custodians state this explicitly in their own agreements, and the statement is accurate.
There is a practical consequence that surprises people. The account, not the individual, is the party to the transaction. Title, the note, the mortgage, the expenses and the income all belong to the account. Paying an expense personally or receiving income personally is not a shortcut. It is the kind of act that creates the problems described next.
This is one piece of a bigger picture; Cash Property Offers has the rest.
Prohibited transactions and disqualified persons
This is the part that requires professional guidance, stated here only at a conceptual level so you know the vocabulary before you talk to someone qualified.
The tax code restricts transactions between a retirement account and certain people and entities related to the account owner. Those people and entities are referred to as disqualified persons, a category that generally includes the account owner, certain family members, and entities in which disqualified persons hold specified interests. The exact definitions are technical and the boundaries are not intuitive.
Transactions between the account and a disqualified person may constitute prohibited transactions. So can using the account's assets for personal benefit. The consequences can be severe, potentially affecting the tax status of the account rather than only the individual transaction.
The practical version: the account cannot be used to benefit you personally today, and the line is drawn in places that catch people who believed they were being reasonable. There is no do-it-yourself version of this analysis.
UBIT exists, and that is as far as this page goes
Retirement accounts are generally tax-advantaged. That treatment is not unlimited.
Unrelated business income tax is a concept under which certain income earned inside a tax-exempt account can be taxable. A related concept, unrelated debt-financed income, can apply where an account's asset is acquired with borrowed money. Whether either applies to a given account and a given asset depends on the specific facts, the type of income, and how the investment is structured.
That is the entire treatment this website is going to give the subject, deliberately. Anything more specific would be tax advice, and tax advice from a webpage about a rule this technical would be actively harmful. The only correct next step is a CPA who works with self-directed accounts. Ask them before the account acquires anything, not at the following April.
Questions to take to a professional
- Is my account type eligible to hold the asset I am contemplating?
- Who are the disqualified persons in my specific situation, and does any party to this transaction fall into that category?
- Does anything about this structure create a prohibited transaction risk?
- Could this generate unrelated business income or debt-financed income, and what would that mean for my account?
- How are expenses paid and income received so that everything stays inside the account?
- What are the custodian's fees, processing timelines and documentation requirements?
- How is the asset valued for annual reporting, and who supplies that valuation?
- What happens if I need liquidity and the account holds an illiquid asset?
Nothing on this page is a recommendation to use a retirement account for anything, and nothing on this site is an offer or a solicitation. This is vocabulary, provided so that the conversation with your own professionals starts further along.
Frequently asked
Questions people actually ask
What is a self-directed IRA?
A retirement account held at a custodian whose platform permits assets beyond publicly traded securities, which in some cases includes real property and notes secured by real property. Self-directed refers to who selects the asset, not to a relaxation of the rules.
Does the custodian check whether an investment is sound?
Generally no. Custodians administer accounts, process directed transactions and handle reporting. They do not evaluate assets, verify valuations or vet operators, and many say so plainly in their own agreements.
What is a prohibited transaction?
At a conceptual level, a transaction between the account and a disqualified person, or a use of account assets for personal benefit. The definitions are technical and the consequences can affect the account's tax status. This is a question for a CPA, not a website.
Who is a disqualified person?
Generally the account owner, certain family members and entities in which disqualified persons hold specified interests. The precise boundaries are technical and not intuitive, which is exactly why the analysis belongs with a qualified professional.
What is UBIT?
Unrelated business income tax — a concept under which certain income earned inside a tax-advantaged account can be taxable, with a related concept applying to debt-financed income. Whether it applies depends on specific facts. Ask your CPA before acquiring anything, not afterward.
Can I use my IRA to fund a property I will use?
Personal use of an account asset is precisely the area the prohibited transaction rules address, and the answer is not something a website should give you. Take that question to a CPA and an attorney before anything happens.
Make your next move
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