When investors look up “IRA capital gains tax,” they usually want to answer one of two questions:
- How does the IRS treat gains on investments in my IRA?
- What does that mean for my retirement strategy?
At Preferred Trust Company we regularly help clients with this topic, especially when they start investing in alternative assets through a self-directed IRA (SDIRA). The rules differ from those of a taxable brokerage account. Understanding them can make a big difference in maximizing retirement savings and avoiding tax surprises.
In this article, we’ll cover the basics of how capital gains are treated in IRAs. We’ll explain the differences between Roth and Traditional IRAs, and highlight special considerations like Unrelated Business Taxable Income (UBTI) and Unrelated Debt Financed Income (UDFI) that can affect self-directed investors.
Roth IRA Capital Gains Tax
The good news for Roth IRA owners is that qualified distributions are tax-free. This includes any capital gains made within the account.
Qualified distributions happen when the account has been open for at least five years, and the owner is either 59½ years old or older, disabled, or meets another qualifying event, such as the first-time homebuyer rule.
Until you withdraw money, you do not report or pay taxes on gains, whether they come from stocks, private equity, real estate, or other IRS-approved assets.
For example:
| An investor contributes $6,000 each year to a Roth IRA and invests those funds in a private real estate offering. Ten years later, her investment has doubled. At age 62, she withdraws $50,000 in gains. Since the account meets the five-year rule and age requirements, the entire $50,000 is withdrawn tax-free. |
This ability to permanently avoid taxes on investment gains is one of the strongest benefits of Roth accounts, especially for long-term investors in alternative assets.
Are Capital Gains Taxed in a Roth IRA?
The short answer is no, just as long as the funds stay in the account. Roth IRAs grow tax-free. However, non-qualified withdrawals may lead to taxes.
Briefly, here’s how it works:
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Withdrawals happen in a specific order:
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Contributions first
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Conversions second, and…
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Earnings last
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You can always withdraw contributions without paying taxes or penalties.
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Earnings withdrawn before the 5-year requirement or before age 59½ might face ordinary income tax plus a 10% penalty, unless an exception applies.
Short case study:
| An investor opens a Roth IRA at age 40, puts money into cryptocurrency, and makes a big gain after two years. If he withdraws the earnings before age 59½, those gains may be taxed and penalized because the withdrawal is not considered “qualified”. |
The key takeaway is to keep funds in the Roth IRA until withdrawals are qualified, so the IRS does not take a share of your capital gains.
Traditional IRA Capital Gains Tax
Traditional IRAs work differently. You don’t pay capital gains tax when you sell assets inside the account. Instead, all withdrawals are taxed as ordinary income, not at capital gains rates.
For example:
| A Traditional IRA buys a rental-focused real estate investment trust (REIT) for $50,000 and later sells it for $70,000. The $20,000 gain isn’t taxed right away; however, when the investor withdraws $20,000 at age 73 as part of required minimum distributions (RMDs), that withdrawal is taxed as ordinary income. |
This makes Traditional IRAs valuable if you expect to be in a lower tax bracket during retirement. Taxes are deferred but not eliminated.
A Self-Directed Twist: UBTI and UDFI
Most IRA investments grow without tax (Traditional) or tax-free (Roth). However, some activities can result in current taxes inside the IRA:
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Unrelated Business Taxable Income (UBTI) is created when the IRA invests in an operating business through a pass-through entity.
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Unrelated Debt-Financed Income (UDFI) occurs when the IRA uses borrowed money, like a non-recourse loan, to purchase assets such as real estate.
In these situations, the IRA may owe tax and needs to file IRS Form 990-T.
For example:
| A self-directed IRA uses 50% non-recourse financing to buy an apartment. When the property is sold, half the gain comes from the borrowed funds. The IRA must file Form 990-T and pay taxes on that gain. |
Although less common, UBTI and UDFI can lower returns if not planned for. Working with a qualified custodian and CPA helps ensure everything is done correctly.
How Preferred Trust Company Supports Investors
As a licensed custodian in Nevada, Preferred Trust Company provides custody and administration for self-directed IRAs. We don’t offer tax or legal advice, but we support investors by:
Executing client-directed transactions in IRS-approved alternative assets.
Coordinating filings like Form 990-T when UBTI or UDFI apply.
Offering both Traditional and Roth account structures for tax planning flexibility.
By understanding how IRA capital gains tax rules apply and the differences between Roth and Traditional accounts, you can better match your retirement strategy with your financial goals.
