When opening and investing with a Self-Directed Individual Retirement Account (SDIRA), it is important to remember that there are IRS rules and regulations that must be followed, and if these rules are disregarded in any way, the IRA could be disqualified. Some of these rules and regulations are outlined in the information below and will help keep you on the right track while your IRA portfolio continues to grow.
IRS Rules for Self-Directed IRAs
Even though the IRS has not drafted a list of acceptable transactions within an IRA, they have outlined the kinds of transactions that are not allowed.
Prohibited Transactions: Prohibited transactions are one of the most important areas to understand when investing with Self-Directed IRAs. Engaging in a prohibited transaction can result in severe consequences, and this could include the disqualification of the entire IRA resulting in tax and/or penalties. An example of a prohibited transactions includes self-dealing, which occurs when the account owner personally benefits from the IRA's assets or engages in any transactions that involve any disqualified individuals, such as certain family members or business partners.
Disqualified Persons: According to the IRS, it is important to understand who identifies as a disqualified person. Disqualified persons include the IRA account owner, their spouse, ancestors such as parents and grandparents, descendants such as children and grandchildren, and any relations in which the account holder has significant ownership or interest. Transactions involving any of these individuals are considered prohibited and are not allowed, which can lead to penalties, and disqualification of the IRA.
Documentation and Record Keeping: Proper documentation and record keeping are essential when managing a Self-Directed IRA. It’s important to maintain clear, detailed records of all transactions to ensure they remain within IRS guidelines. Doing so not only helps protect the IRA’s qualified status but also provides valuable support in the event of an audit or regulatory review.
Prohibited Investments: Although Self-Directed IRAs provide access to a broad range of investment opportunities, certain assets are strictly prohibited. These include life insurance and collectibles such as artwork, antiques, stamps, and bottles of alcohol. Assets with subjective value can be difficult to track and monitor, making them problematic from an IRS compliance standpoint. Because their worth is often based on fluctuating markets and personal preferences, accurately valuing these items can pose significant challenges.
Custodian Requirement: A Self-Directed IRA must be held by an IRS-approved custodian or trustee. The custodian plays a vital role in ensuring the account remains compliant with all applicable regulations and is responsible for managing the administrative duties associated with the IRA. This includes maintaining proper records, filing necessary IRS forms, and ensuring that all transactions follow IRS rules. Without a qualified custodian, your IRA could fall out of compliance, putting the tax-advantaged status of your account at risk.
Self-Directed Roth IRA Rules
Self-directed Roth IRAs give individuals the opportunity to diversify their retirement portfolios and go beyond the traditional stocks, bonds, and mutual funds. However, these accounts come with specific rules and guidelines that must be followed to stay in compliance with the IRS. Much like a Traditional self-directed IRA, a self-directed Roth IRA is a powerful tool for individuals who want to invest in alternative assets while enjoying tax-free growth on qualified withdrawals. However, it is important to understand the rules related to these types of accounts.
Contribution Limits: Roth IRA contribution limits are set by the IRS and can vary based on your age. For 2025, individuals under the age of 50 can contribute up to $7,000 annually, while those aged 50 and older are allowed to contribute up to $8,000, thanks to the additional catch-up contribution provision.
Income Requirements: Roth IRAs are subject to income limits based on your modified adjusted gross income (MAGI), which can affect how much you're eligible to contribute. For 2025, individuals filing as single can make a full contribution if their MAGI is less than $146,000, with the ability to contribute phasing out between $146,000 and $161,000. For married couples filing jointly, full contributions are allowed with a MAGI below $230,000, and the phase-out range extends from $230,000 to $240,000. If your income falls above these thresholds, your contribution may be reduced or eliminated altogether.
Qualified Withdrawals: Roth IRA withdrawals are tax-free if certain conditions are met. To qualify, the account must have been open for at least five years, and the withdrawal must occur after age 59½ or meet an approved exception, such as using the funds for a first-time home purchase. Meeting these criteria ensures you can access your earnings without paying taxes or penalties.
Self-Directed IRA – Rules for Real Estate Investments
Real estate is one of the most popular investments for self-directed IRAs due to the potential for returns and diversification. However, the rules for investing in real estate with an SDIRA are very strict and must be followed.
Investment Property Use: Any property owned by your IRA must be used strictly for investment purposes and cannot provide personal benefit. This means you, your family members, or any other disqualified individuals are not allowed to live in, vacation at, or otherwise use the property in any capacity.
Prohibited Transactions: All real estate transactions within an IRA must be conducted at “arm's length,” meaning they must be made strictly for investment purposes and without any personal involvement. For instance, you cannot purchase property from certain family members or rent IRA-owned property to a family member or other disqualified person. These types of transactions are prohibited and can jeopardize the tax-advantaged status of your IRA.
Management and Maintenance: You are not permitted to personally manage or perform maintenance on property held within your IRA. Instead, all management and upkeep must be handled by independent, third-party professionals to ensure compliance with IRS rules.
Funding and Expenses: All costs associated with the property, including taxes, maintenance, and improvements, must be paid directly from the IRA to maintain proper compliance. It’s important that no personal funds are used for these expenses. Likewise, any income generated by the property, such as rent or sale proceeds, must be returned directly to the IRA. Keeping all financial activity within the IRA helps preserve its tax-advantaged status and ensures a clear separation between personal and retirement funds.
UBIT and UDFI: What You Need to Know
When investing through a Self-Directed IRA, it’s important to understand the potential impact of Unrelated Business Income Tax (UBIT) and Unrelated Debt-Financed Income (UDFI). These taxes can apply in certain situations and may reduce the tax advantages of your IRA.
UBIT generally applies when your IRA earns income from an active business or partnership rather than passive investments. For example, if your IRA invests in a business where it actively participates, that income could be subject to UBIT.
UDFI is a type of UBIT that applies when your IRA uses borrowed money to purchase an investment, such as real estate with a mortgage. The income generated from the portion of the investment financed by debt may be taxable under UDFI rules.
Common investments that can trigger UBIT or UDFI include operating businesses, partnerships, and real estate purchased with a loan. To avoid these taxes, it’s important to focus on passive investments, like rental properties owned outright, dividends, and interest income, which typically do not generate UBIT or UDFI.
Always consider the tax implications before using leverage or investing in an active business through your IRA. Consulting a tax professional experienced with Self-Directed IRAs can help you navigate these rules and protect the tax-advantaged status of your account.
Required Minimum Distributions (RMD)
Traditional Self-Directed IRAs are subject to Required Minimum Distributions (RMD) rules starting at age 73, as established by the SECURE Act 2.0. The IRS calculates the annual RMD amount based on your account balance at the end of the previous year and your life expectancy, using IRS life expectancy tables. This information is provided on Form 5498, which your custodian files each year.
If you have multiple IRA accounts, you must calculate the total RMD amount by combining the balances from all your IRAs using the life expectancy factor. However, you have the flexibility to withdraw the total RMD from any one or a combination of your IRA accounts.
It’s crucial to take at least the required minimum amount each year because failing to do so can result in a penalty of up to 25% of the amount that should have been withdrawn. Careful planning of your distributions ensures you stay compliant and avoid unnecessary penalties while managing your retirement income effectively.
Penalties for Early Withdrawal
Withdrawals from a Self-Directed IRA made before age 59½ are generally subject to a 10% early withdrawal penalty, unless they qualify for specific exceptions such as a first-time home purchase or certain qualified medical expenses. Staying compliant with these withdrawal rules helps ensure your investments continue to grow tax-deferred or tax-free, in the case of Roth IRAs.
By integrating these regulations into your investment strategy and regularly monitoring your IRA activity, you can protect your account and maximize its long-term growth potential. Staying informed and working with experienced tax and financial professionals will help you maintain compliance while confidently working toward lasting financial security.
The Importance of Staying Compliant
Maintaining compliance with self-directed IRA rules is essential to preserving the tax-advantaged status of your account. Violations, such as engaging in prohibited transactions or failing to report accurately, can result in costly penalties, unexpected taxes, and even disqualification of the entire IRA. For this reason, partnering with a knowledgeable custodian and financial advisor is highly recommended to help you navigate the complexities of self-directed IRAs.
Before diving into self-directed investing, it’s crucial to conduct thorough research and determine whether this strategy aligns with your long-term financial goals. Understanding your responsibilities as an account holder, including performing due diligence when selecting investments and regularly monitoring your account activity, is key to achieving success.
The IRS requires detailed reporting for self-directed IRAs. Account holders must ensure the accurate filing of Form 5498, which documents contributions, rollovers, and fair market values. Additionally, income generated from certain investments, such as unrelated business taxable income (UBTI), must be reported and may be subject to taxation. Failure to meet these reporting requirements can trigger audits and penalties.
Staying informed about changes to IRS regulations is equally important. Tax laws evolve, and what is permissible today might be restricted tomorrow. Scheduling regular account reviews and continuing to seek expert guidance will help ensure your IRA remains compliant and continues to serve as an effective vehicle for your retirement goals.
Conclusion:
Navigating the rules of a self-directed IRA can feel complex, but understanding and following them is essential to maintaining the tax-advantaged status of your account. From avoiding prohibited transactions to keeping accurate records and working with qualified custodians, staying compliant protects your retirement strategy. Whether you’re investing in real estate, private businesses, or other alternative assets, approaching every decision with diligence, transparency, and expert guidance is key. As IRS regulations change over time, staying informed will help keep your financial future secure and your IRA on the right path.
