Real estate and retirement accounts make a powerful combination, but only if you play by the rules.
Every year, we meet seasoned investors who know how to find great deals but accidentally break IRS rules when using their retirement funds to invest. The result? Unexpected taxes, penalties, and, in some cases, a fully disqualified IRA.
If you’re a real estate investor exploring how to use a Self-Directed IRA (SDIRA) to build wealth, this guide covers the key concepts you need to understand before making your first purchase.
What Makes Real Estate Investing Inside an IRA So Powerful
A Self-Directed IRA gives you the same tax advantages as a Traditional or Roth IRA, but with the flexibility to invest in real property, notes, or private entities instead of just Wall Street assets.
That means you can:
- Buy rental properties or rehab projects,
- Lend money as a private note investor,
- Participate in syndications or partnerships,
- Or even hold raw land, all within your retirement account.
The profits flow back into your IRA, allowing you to grow your portfolio tax-deferred or tax-free. But this freedom comes with responsibility. The IRS allows a wide range of investments, but strictly prohibits certain transactions and relationships.
Understanding “Disqualified Persons”
The IRS restricts who your IRA can transact business with. These are called Disqualified Persons, and they include:
- You, the IRA owner
- Your spouse
- Your lineal descendants and ascendants (parents, grandparents, children, grandchildren)
- Their spouses
- Any entity (LLC, corporation, partnership) owned or controlled by any of the above
Think of your IRA as a separate legal entity. It’s designed to benefit your future self, not your current family circle.
So, your IRA cannot:
- Buy a property you or your family currently own,
- Rent property to your child, parent, or spouse,
- Pay yourself a management fee, or
- Sell assets to or from your own business.
Even well-meaning investors can cross this line without realizing it. Especially when trying to “help” family members or co-investors.
Prohibited Transactions: The Rules That Can Disqualify Your IRA
A prohibited transaction occurs when your IRA engages in any direct or indirect benefit involving a disqualified person.
Common examples include:
- Personal benefit: Using an IRA-owned property for vacation or storage.
- Sweat equity: Performing repairs or managing the property yourself.
- Guaranteeing loans personally: Your IRA must stand alone-no personal guarantees or pledges of collateral.
- Improper funding: Paying IRA expenses with personal funds or depositing rent into your personal account.
Even one prohibited transaction can cause the entire IRA to lose its tax-advantaged status, triggering income tax and potential penalties on the account’s full value.
How to Avoid Common Mistakes
Real estate investors are creative by nature, but when it comes to IRAs, structure matters more than ingenuity. Here are the top ways to stay compliant:
✅ Keep Transactions Arm’s Length. All income and expenses must flow in and out of the IRA directly through your custodian, not your personal accounts.
✅ Use Professionals for Property Management. You can hire third-party vendors, contractors, and managers but you and other disqualified persons can’t perform the work yourselves.
✅ Track Ownership Accurately. Title must always reflect the IRA, such as: MidAtlantic IRA, LLC FBO [Your Name] IRA. This prevents confusion during audits, FMV reporting, and eventual sales.
✅ Document Everything. Keep clean paper trails for:
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- Purchase agreements
- Expense receipts
- Rental income deposits
- Year-end Fair Market Valuations
It’s not glamorous, but documentation is the single best protection against IRS scrutiny.
Structuring Deals the Right Way
If you’re working with partners or forming an LLC, proper structure is everything. The IRS allows your IRA to partner with yourself or others, as long as the ownership is established at the time of purchase and remains consistent through every transaction.
That means:
- You can use both personal and IRA funds to buy a property together (for example, 60% from your IRA and 40% personally).
- But those percentages must stay the same for the life of the investment.
- All income, expenses, and future improvements must be split according to that original ownership ratio.
You cannot shift ownership later, pay an expense personally for the IRA’s portion, or transfer value between your IRA and yourself. Doing so would create an indirect benefit, a prohibited transaction under IRS rules.
Lessons from the Field
During recent Strategy Group calls, we’ve seen examples of both success and caution:
- One investor used their SDIRA to purchase a rental duplex in Florida, earning consistent, tax-deferred rental income for years.
- Another unintentionally triggered a prohibited transaction by paying for roof repairs personally, turning a small expense into a major tax issue.
The difference? Education and planning.
Working with an experienced custodian who specializes in self-directed accounts can help you identify potential red flags before they become costly mistakes.
Disclaimer: MidAtlantic IRA, LLC does not provide investment, tax, or legal advice. Individuals should consult appropriate professionals before making any investment decisions.