How an SDIRA holds real estate
A self-directed IRA (SDIRA) is an IRA whose custodian permits alternative investments, including real estate. The IRA — not you personally — owns the property. All income flows back to the IRA, tax-deferred (traditional) or potentially tax-free (Roth). You cannot take personal use of the property, pay expenses from personal funds, or benefit from it outside the IRA without triggering a prohibited transaction.
The prohibited transaction rules under IRC § 4975 bar any transaction between the IRA and a disqualified person — you, your spouse, lineal descendants, ancestors, or entities you or they control. Violating these rules disqualifies the entire IRA, triggering immediate taxation of all assets.
No depreciation deduction
Because the IRA — not you — owns the property, you cannot claim depreciation on your personal tax return. The IRA itself is tax-exempt, so depreciation has no value inside it. This is a significant difference from direct ownership: one of the main benefits of owning rental property personally (depreciation against income) is lost inside an IRA.
UDFI: Tax on leveraged investments
If the SDIRA uses a mortgage (debt-financing), a portion of the rental income becomes Unrelated Debt-Financed Income (UDFI), subject to Unrelated Business Income Tax (UBIT) at trust rates — which can be quite high. The UBIT on UDFI is computed on Form 990-T, filed by the IRA custodian. This surprise tax often catches SDIRA investors off guard: they expected tax-free income but get a UBIT bill when leverage is involved.
An all-cash purchase inside the SDIRA avoids UDFI entirely, but eliminates the leverage that makes real estate attractive to many investors.
Frequently asked questions
Can I live in a property owned by my self-directed IRA?
No. Using SDIRA-owned property for personal benefit — even a vacation — is a prohibited transaction that immediately disqualifies the entire IRA.
Can a Roth SDIRA own real estate?
Yes. A Roth SDIRA can own real estate. All income and appreciation grow tax-free, and qualified distributions at retirement are tax-free — a powerful combination if the property appreciates significantly.
What is UBTI/UBIT in an SDIRA?
Unrelated Business Taxable Income (UBTI) is income earned by a tax-exempt entity (like an IRA) from a trade or business unrelated to its exempt purpose, or from debt-financed property. The IRA pays tax on this income at trust rates via Form 990-T.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.