Self-Directed IRA Real Estate and Private Credit

How it works

A self-directed IRA is governed by the same section of the tax code as any other IRA. The only real difference is the custodian: a trust company willing to hold non-traded assets like property, notes, and fund interests, and process the paperwork that goes with them. That custodian is a passive record-keeper. It does not vet the investment, does not check whether a sponsor is legitimate, and every reputable one puts that disclaimer in writing. Due diligence is entirely the account holder's job.

The IRA itself is the buyer, not the person behind it. Title reads something like 'XYZ Trust Company FBO [name] IRA,' the earnest money comes from the IRA's cash, and every expense afterward — taxes, insurance, repairs, legal fees — must also come from the IRA. Two structures carry out this buying. Custodian-directed accounts submit each transaction to the custodian for execution. Checkbook control accounts have the IRA own a single-member LLC with its own bank account that the holder signs on directly, which is faster but far easier to misuse.

For real estate, the IRA collects rent and pays every operating cost, with the net staying inside the account; professional management is standard practice because doing the work personally risks a prohibited transaction. For private credit, the IRA lends against a note and deed of trust or buys into a fund, and payments route to the custodian for the account's benefit, never to the individual.

IRC 4975 defines disqualified persons broadly — the account holder, spouse, ascendants and descendants and their spouses, plan fiduciaries, and entities they control at 50% or more. No buying from, selling to, lending to, renting to, or providing services to any of them through the IRA. A prohibited transaction is not a fine; the IRA is treated as having distributed its entire balance on January 1 of the violation year, with full tax and any early-distribution tax applied to the whole amount. Debt-financed real estate and pass-through operating businesses generate unrelated debt-financed or unrelated business taxable income, taxed to the IRA at trust rates on Form 990-T. Because the IRA itself borrows, any mortgage must be non-recourse, a small lending niche with larger down payments and higher rates. An annual fair market valuation, usually a third-party appraisal or sponsor statement, is required for custodian reporting and later RMD calculations.

What it pays

Rental income, net of every expense the IRA has paid, is usually described as a cap rate on the property or a cash-on-cash return, driven by the property's net operating income, its financing terms, and local rental demand. Private notes pay a contract interest rate plus any origination points, set by the borrower's credit, the loan-to-value ratio, lien position, and how much competing capital the borrower could otherwise reach.

Whatever the asset earns is not taxed as it arrives. Deferral inside a traditional account, or exemption inside a Roth, is the entire purpose of holding the asset in this wrapper rather than outright. That said, the deductions that make real estate attractive in a taxable account — depreciation, mortgage interest, the qualified business income deduction — do nothing here, because there is no taxable income at the individual level for them to offset.

Distributions later from a traditional self-directed IRA are ordinary income regardless of how they were earned, so a gain that would have been taxed at long-term capital gains rates outside the account comes out taxed at ordinary income rates once withdrawn. The illiquidity premium the underlying asset pays is the real source of return, and it exists independent of the retirement wrapper around it.

Costs and taxes

Custodian fees are the most visible cost: an account establishment fee, an annual fee that may scale with the number or value of assets held, and transaction fees for each purchase, each note payment processed, and each document reviewed. A checkbook LLC adds its own layer — formation cost, state filing fees, a registered agent, and annual state compliance.

Non-recourse financing, when used, is stricter and pricier than a conventional mortgage: a larger down payment, a higher rate, and a shorter amortization. An appraisal or valuation is needed every year to support the fair market value report the custodian files. When unrelated business or debt-financed income crosses the filing threshold, the custodian files Form 990-T on the IRA's behalf and the tax is paid from IRA assets, not personally.

All the ordinary IRA rules still apply on the way out — ordinary income taxation from a traditional account, the additional 10% tax before age 59½ absent an exception, and required minimum distributions in due course. State-level costs, including property tax, transfer tax, insurance, and in some states an LLC franchise fee, land on the IRA as well.

Liquidity and time commitment

This is among the least liquid things a retirement account can hold. A property can take months to sell, a note pays only on its stated schedule, and a private fund interest may have no secondary market at all. Cash discipline is structural rather than optional: the IRA must keep enough cash on hand to cover a roof, a vacancy, or a tax bill, because the account holder cannot legally lend the IRA money or pay its bills personally. Annual contributions, within IRA limits, are the only legal way to add funds.

Required minimum distributions against an illiquid asset are a recurring squeeze. The distribution is owed in cash on a fixed schedule, but the asset cannot be sold in slices, which forces either an in-kind distribution of a fractional interest or a rushed sale at a worse price.

Even with a property manager or fund sponsor doing the operational work, time commitment is real: approving expenses, routing every dollar through the custodian, gathering annual valuations, and monitoring the borrower or sponsor's performance. Custodian processing adds days to each transaction, which pushes some holders toward checkbook LLC structures for speed — and checkbook structures are exactly where more compliance failures occur.

How it goes wrong

Paying a repair bill on a personal credit card because it is faster extends credit to the IRA — a prohibited transaction that can be treated as distributing the entire account. Spending a night in the IRA's vacation property, or letting an adult child live in it rent-free, is self-dealing with a disqualified person. Doing the renovation labor personally — 'sweat equity' — counts as a service to the plan and is prohibited even when uncompensated.

Lending IRA funds to a business the holder owns or controls at the 50% threshold is prohibited, as is financing a property with a recourse mortgage personally guaranteed, which triggers both a prohibited-transaction problem and a debt-financed income issue.

Operational failures compound the legal ones: running the account's cash to zero with no legal way to inject funds beyond the annual contribution limit, then being unable to pay an insurance renewal; ignoring a Form 990-T obligation on a leveraged property and discovering years of unpaid trust-rate tax plus interest; letting custodian and LLC fee drag exceed whatever tax advantage a small account was capturing in the first place.

The most common failure in published enforcement cases is simpler than any of these — treating a custodian's willingness to hold an asset as an endorsement of the sponsor behind it. The custodian is a record-keeper, not a regulator, and it says so in the paperwork every account holder signs.