Self-directed IRAs are powerful tools for building retirement wealth beyond traditional stocks and bonds. You can invest in real estate, private companies, precious metals, and more.
But here’s the catch: the IRS has strict rules. Break them, and you could face massive penalties, tax bills, and even disqualification of your entire IRA.
Most Self Directed IRA Companies will warn you about these rules, but ultimately it’s your responsibility to follow them. The IRS doesn’t care if you didn’t know. Ignorance isn’t a defense.
Understanding these rules isn’t optional if you’re using a self-directed IRA. One mistake can wipe out years of tax-advantaged growth.
Let’s walk through the critical IRS rules you absolutely must follow.
The Prohibited Transaction Rules
This is the big one. The IRS has strict rules about who you can do business with using your IRA.
You cannot use your IRA to benefit yourself or certain related people.
These people are called “disqualified persons” and include:
- You (the IRA owner)
- Your spouse
- Your parents and grandparents
- Your children and grandchildren
- Your spouse’s parents and grandparents
- Any business you own 50% or more of
- Fiduciaries of the IRA (like your IRA custodian)
What this means in practice:
- You can’t buy property from your dad and put it in your IRA.
- You can’t sell an asset from your IRA to your daughter.
- You can’t invest IRA money in a business you own 50% of.
- You can’t rent IRA-owned property to your son.
- Your spouse can’t manage a property owned by your IRA.
The IRS is extremely strict about this. Even indirect benefits to disqualified persons can trigger penalties.
The Self-Dealing Rule
This is closely related to prohibited transactions but worth highlighting separately.
You cannot personally benefit from IRA assets before retirement.
Even if you’re not directly transacting with disqualified persons, you can’t use IRA assets for personal benefit.
Examples of prohibited self-dealing:
- Your IRA owns a rental property. You can’t live in it, even if you pay rent.
- Your IRA owns a vacation home. You can’t use it for weekends, even once a year.
- Your IRA owns a storage facility. You can’t store your personal stuff there.
- Your IRA invests in your friend’s business. You can’t work for that business and get paid.
The IRA benefit must stay entirely within the IRA. You get zero personal use or benefit until you take distributions in retirement.
The No Personal Services Rule
You cannot provide services to your IRA investments and get paid for it.
Your IRA buys a fixer-upper rental property. You’re a contractor. Can you fix it up and pay yourself from IRA funds?
Nope. That’s prohibited.
You can’t:
- Pay yourself to manage IRA properties
- Hire yourself to do repairs
- Compensate yourself for finding deals
- Pay yourself commissions on IRA investments
Now, you CAN provide services for free. You could manage your IRA’s rental property without compensation. But the second you withdraw from your IRA, you’ve violated the rules.
Most people hire third parties for property management, repairs, and maintenance. It costs more, but it keeps you compliant.
The No Personal Guarantee Rule
Your IRA investments must stand on their own. You can’t personally guarantee them.
Common mistake:
Your IRA wants to buy a rental property. The bank requires a personal guarantee on the mortgage.
You can’t do that. The loan must be non-recourse, meaning the lender’s only security is the property itself, not you personally.
This makes financing an IRA real estate harder and more expensive. Non-recourse loans typically have:
- Higher interest rates
- Larger down payments (often 30-40%)
- Shorter terms
- Fewer lenders are willing to offer them
But that’s the rule. You or any disqualified person cannot personally guarantee your IRA’s investments.
The Unrelated Business Income Tax (UBIT)
Here’s something that surprises people: IRAs can owe taxes even though they’re tax-advantaged accounts.
UBIT applies when:
Your IRA earns income from an active business (not passive investments).
Your IRA uses debt financing (like a mortgage).
Example 1 – Active business income:
Your IRA invests in an operating business that generates profits. Those profits may be subject to UBIT.
Example 2 – Leveraged real estate:
Your IRA buys a rental property with a mortgage. The portion of income attributable to the debt is subject to UBIT.
If your IRA has a $100,000 property with a $60,000 mortgage, roughly 60% of the income could be taxable under UBIT rules.
UBIT doesn’t disqualify your IRA, but it does create a tax bill your IRA has to pay. Many people don’t realize this when they leverage IRA real estate.
The Exclusive Benefit Rule
Everything your IRA does must be for the exclusive benefit of the IRA and its beneficiaries.
You can’t mix personal and IRA funds.
You can’t use IRA assets for anything other than building retirement wealth.
Common violations:
Paying personal expenses from IRA funds (even temporarily).
Mixing personal money with IRA money in the same investment.
Using IRA property for personal purposes.
Making IRA investment decisions primarily to benefit someone else.
The IRA exists solely to provide retirement benefits. Period.
Contribution Limits Still Apply
Just because you have a self-directed IRA doesn’t mean you can contribute unlimited amounts.
2024 contribution limits:
- Under 50: $7,000 per year
- 50 and older: $8,000 per year (with catch-up)
These are total IRA contributions across all your IRAs. If you have three different IRAs, you still can’t contribute more than the annual limit combined.
People sometimes think they can contribute more because they’re buying real estate or making large investments. Nope. The limits apply regardless of how you invest.
Required Minimum Distributions (RMDs)
Once you hit age 73 (as of 2024), you must take required minimum distributions from traditional IRAs.
Self-directed IRAs aren’t exempt from this.
The problem:
If your IRA owns illiquid assets (real estate, private companies), taking RMDs can be complicated.
You might need to:
- Sell part of an asset (not always possible)
- Take in-kind distributions (transfer the asset to yourself)
- Keep some liquid funds in the IRA specifically for RMDs
Plan for this ahead of time. Don’t put 100% of your IRA into illiquid investments if you’re approaching RMD age.
The Step Transaction Doctrine
The IRS looks at substance over form. They’re watching for schemes designed to circumvent the rules.
Example of what NOT to do:
You want to buy your mom’s rental property in your IRA (prohibited transaction).
So you have your mom sell it to your friend, then your IRA buys it from your friend a week later.
The IRS sees through this. They’ll treat it as if you bought it directly from your mom, which is prohibited.
They call this the “step transaction doctrine.” They look at the economic substance, not just the technical structure.
Don’t try to be clever with workarounds. If something feels like it’s skirting the rules, it probably is.
No Collectibles
IRAs cannot invest in collectibles. This includes:
- Artwork
- Antiques
- Rugs
- Stamps
- Most coins (except specific bullion coins)
- Alcoholic beverages
- Certain other tangible personal property
Exception: Specific precious metals bullion that meets IRS fineness standards:
- Gold (99.5% pure)
- Silver (99.9% pure)
- Platinum (99.95% pure)
- Palladium (99.95% pure)
Even then, the precious metals must be held by an approved custodian, not in your personal possession.
Proper Documentation Requirements
The IRS requires detailed records of all IRA transactions.
You must maintain:
- All purchase and sale documents
- Receipts for expenses paid by the IRA
- Income records
- Fair market valuations
- Correspondence related to investments
Your IRA custodian will require documentation for every transaction. Keep everything organized.
If you get audited, the IRS will want to see that all transactions were legitimate, properly valued, and didn’t involve prohibited persons.
Fair Market Value Rules
IRA assets must be valued at fair market value annually.
For stocks and bonds, this is easy – there’s a market price.
For real estate, private companies, or other alternative assets, you need proper valuations.
Some custodians require:
- Professional appraisals for real estate
- Business valuations for private companies
- Documented methodology for valuing other assets
Don’t just make up numbers. The IRS can challenge improper valuations, especially if you’re undervaluing assets to reduce RMDs or overvaluing to make your IRA look better.
Penalties for Violations
Break these rules, and the consequences are severe:
Prohibited transaction penalties:
- 15% excise tax on the transaction amount
- Additional 100% tax if not corrected
- Potential disqualification of the entire IRA
IRA disqualification:
If the IRS disqualifies your IRA, the entire balance becomes taxable income immediately. Plus:
- You owe ordinary income tax on the full amount
- 10% early withdrawal penalty if under 59½
- Loss of all future tax-advantaged growth
A $500,000 IRA disqualified could trigger a $200,000+ tax bill instantly.
This isn’t a slap on the wrist. It’s financial devastation.
How to Stay Compliant
Here’s how to avoid problems:
Work with knowledgeable professionals. Use a custodian experienced with self-directed IRAs. Consult a CPA who understands self-directed IRA rules.
Document everything. Keep detailed records of all transactions, decisions, and valuations.
Avoid gray areas. If you’re not 100% sure something’s allowed, don’t do it. The risk isn’t worth it.
Plan for liquidity. Keep some liquid assets in your IRA for RMDs, fees, and unexpected expenses.
Never mix personal and IRA assets. Maintain complete separation.
Review transactions carefully. Before making any investment, verify it doesn’t involve disqualified persons.
Get valuations right. Use professional appraisals for hard-to-value assets.
The Bottom Line
Self-directed IRAs offer incredible investment freedom. But that freedom comes with serious responsibility.
The IRS rules aren’t suggestions. They’re hard requirements with massive penalties for violations.
Most violations happen because people don’t understand the rules or think they can work around them. Don’t be that person.
If you’re going to use a self-directed IRA:
- Learn the rules thoroughly
- Work with experienced professionals
- Document everything
- Stay conservative when you’re unsure
The tax advantages are real. But one prohibited transaction can wipe out years of benefits and leave you with a huge tax bill.
Know the rules. Follow them religiously. Protect your retirement savings.
