Self-Directed Retirement Accounts: Rules, Prohibited Transactions, and Risks

A self-directed IRA is an individual retirement account that lets you invest in assets most brokerages won’t touch: real estate, private company shares, promissory notes, tax liens, and certain precious metals. It carries the same tax treatment and the same contribution ceiling as any other IRA — $7,500 in 2026, or $8,600 if you’re 50 or older, counted across all your IRAs combined.¹ The difference is what you can buy and who’s watching. A self-directed IRA custodian holds legal title and files reports with the IRS, but does not evaluate your investments, verify valuations, or warn you when you’re about to break a rule. Every piece of due diligence is on you, and a single wrong move can wipe out the account’s tax status in one year.

What You Can Hold Inside One

The tax code takes a broad approach: an IRA can hold almost any asset that isn’t specifically banned. In practice, self-directed investors commonly use these accounts for residential rentals, commercial buildings, raw land, private equity stakes in startups or established companies, promissory notes secured by real property, and tax lien certificates.

Precious metals are allowed but tightly restricted. Bullion must meet the minimum fineness required for delivery on a regulated commodities exchange — gold at 0.995 fine, silver at 0.999 fine — and must stay in the physical custody of the IRA trustee. A home safe won’t do.² Certain U.S. Mint gold, silver, and platinum coins are allowed, as are coins issued under state law.³

What You Can’t Hold

Life insurance contracts are prohibited from any IRA. Collectibles are treated harshly: buying one with IRA funds is treated as an immediate distribution equal to the purchase price, so you owe income tax on it right away.² The IRS classifies artwork, rugs, antiques, stamps, most coins, gems, alcoholic beverages, and any other tangible personal property it designates as collectibles.³

Because the IRA holds title to every asset, all the income it produces — rent, interest, dividends — flows back into the account and keeps its tax-advantaged status until you take a distribution.

Traditional or Roth

You can set up a self-directed IRA as either a traditional or Roth account, and the choice matters more than it does with a plain stock portfolio. A traditional version gives you a potential deduction now and taxes withdrawals as ordinary income later. A Roth uses after-tax dollars, and qualified withdrawals come out tax-free. If you buy a rental property inside a Roth self-directed IRA and it appreciates substantially over decades, that entire gain can eventually leave the account tax-free. In a traditional account, every dollar you pull out is taxed as ordinary income, regardless of how long you held the asset or how much of the growth was capital appreciation.

Prohibited Transactions: The Fastest Way to Blow Up the Account

The biggest risk in a self-directed IRA isn’t a bad investment. It’s a prohibited transaction. Internal Revenue Code Section 4975 bars almost any exchange of money, goods, or services between the IRA and a “disqualified person.”⁴ The disqualified list is broader than most people expect:

You, the account owner, along with any fiduciary or service provider to the plan.
Your spouse, parents, grandparents, children, grandchildren, and the spouses of your children and grandchildren.
Any corporation, partnership, or trust in which disqualified persons together own 50% or more.
Officers, directors, 10%-or-greater shareholders, or highly compensated employees of a disqualified entity.

In real terms, you cannot buy a vacation home you plan to stay in, rent a property to your daughter, hire your spouse to manage a rental, or lend account money to a business you control. The IRS treats all of these as self-dealing, whether or not money changes hands on fair terms.

The Penalty Is All-or-Nothing

If a prohibited transaction happens at any point during the year, the account stops being an IRA as of January 1 of that year. The entire fair market value is treated as distributed to you on that date.⁵ You owe ordinary income tax on the full balance, and if you’re under 59½, a 10% early withdrawal penalty stacks on top. There is no partial disqualification. One bad transaction can unravel a $500,000 account and cost $200,000 or more in combined taxes and penalties.

Opening and Funding the Account

Most banks and retail brokerages don’t administer self-directed IRAs. You need a specialized trust company or custodian that handles alternative assets. The paperwork looks like any IRA application — ID, Social Security number, beneficiaries — plus a note on where your funding is coming from.

Fees vary widely. Setup charges commonly run from about $50 to $360, and annual fees roughly from $250 to $500, with some custodians using flat rates and others adding per-transaction or per-asset charges. A low setup fee paired with high per-transaction pricing can cost more over time than a higher flat annual rate, so read the full schedule before you commit.

Rollovers From an Existing Retirement Plan

Most self-directed IRA money starts life in an employer plan or a conventional IRA. There are two ways to move it:

A trustee-to-trustee transfer, where funds move directly from one custodian to another. You never touch the money, nothing is taxable, and there’s no limit on how many transfers you can do per year.⁶
An indirect rollover, where you receive a check and must redeposit the full amount into the new IRA within 60 days. Miss the window and the IRS treats it as a taxable distribution. You’re also limited to one indirect IRA-to-IRA rollover per 12-month period across all your IRAs.⁷

The trustee-to-trustee path is safer for most people. Rollovers from a 401(k) or 403(b) into a self-directed IRA are generally not taxable when executed correctly.

How Purchases Actually Happen

Once funds arrive at the custodian, you initiate an investment by submitting written direction that spells out the asset, the price, and the capital to be deployed. The custodian then wires funds or issues a check directly to the seller or escrow. The purchase agreement must list the IRA as the buyer, not you personally. You never handle the money. Even briefly touching it can trigger a taxable distribution.

The Checkbook LLC Option

Some investors want faster execution than the custodian’s paperwork cycle allows. In a “checkbook” arrangement, the IRA invests its full balance into a newly formed LLC. You serve as the LLC’s manager without compensation, and the LLC opens its own bank account. From then on, you can write checks directly instead of routing every transaction through the custodian.

This structure helps when buying at auction or managing rental properties that generate frequent small expenses. The tradeoff is more administrative work and higher upfront costs. Forming the LLC involves legal and state filing fees that commonly run from several hundred to a few thousand dollars, plus annual state fees that vary by jurisdiction. Every prohibited transaction rule still applies. The LLC gives you speed, not permission to self-deal.

Real Estate: Where the Rules Bite Hardest

Real estate is the most common alternative asset in these accounts and where mistakes most often happen. The core rule is that all money flows through the IRA. Every property expense — taxes, insurance, repairs, management fees, mortgage payments — must be paid from IRA funds, and all rental income must return to the IRA. Even covering a plumber out of pocket while waiting for a rent check is a prohibited transaction.

You need enough cash in the account to handle vacancies, surprise repairs, and routine costs. Running out of liquidity in an IRA that holds a building has no clean fix. Writing a personal check disqualifies the account.

Non-Recourse Loans Only

If you want to finance a real estate purchase inside the IRA, the loan must be non-recourse. The lender’s only remedy on default is the property itself; they can’t come after you personally or any other IRA assets. A personal guarantee is a prohibited transaction because it pledges your personal credit to benefit the IRA.⁴ Non-recourse lenders are harder to find, charge higher rates, and usually require larger down payments than conventional mortgages.

Taxes Inside a Tax-Advantaged Account

Most people assume everything inside an IRA grows tax-free or tax-deferred. That’s true for passive income like rent, interest, and dividends. It stops being true when the IRA earns income from an active business or uses debt to finance an investment.

If the account owns an interest in an operating business, the income can be classified as unrelated business taxable income (UBTI). When gross UBTI reaches $1,000 or more in a year, the IRA has to file Form 990-T and pay tax at trust rates.⁸ Each IRA is a separate trust and needs its own EIN.

When the account uses a non-recourse mortgage to buy real estate, the share of income tied to borrowed money becomes unrelated debt-financed income (UDFI). The taxable share tracks the debt ratio: put 40% down and finance 60%, and roughly 60% of the net rental income is subject to UDFI tax. The same $1,000 threshold triggers the Form 990-T filing.⁸

For 2026, trust tax rates on this income start at 10% on the first $3,300 and climb to 37% on amounts over $16,000.⁹ Trust brackets compress much faster than individual brackets, so even modest UBTI or UDFI hits the top rate quickly. The tax is paid from IRA funds, which chews into liquidity.

Valuation and Required Minimum Distributions

Your custodian must file Form 5498 with the IRS by May 31 each year, reporting the account’s fair market value as of December 31. For public securities that’s automatic. For a rental property or private company shares, someone has to produce a defensible valuation, and that someone is you. Custodians are not required to appraise alternative assets or verify the numbers you supply, and courts have consistently held that self-directed IRA custodians are not fiduciaries.

Getting the valuation wrong matters. Understating the value understates your required minimum distribution and triggers a 25% excise tax on the shortfall. Overstating it forces you to pull out more than necessary. For illiquid assets, a professional appraisal every few years is worth the cost.

The RMD Trap for Illiquid Accounts

Traditional IRA owners must begin taking required minimum distributions by April 1 of the year after they turn 73.¹⁰ Roth IRAs are exempt during the owner’s lifetime. If your IRA holds a $400,000 rental and $20,000 in cash, meeting a $15,000 RMD from cash works fine. If the property appreciates and the cash balance doesn’t keep pace, your options narrow: sell the property on a deadline, take an in-kind distribution of a fractional interest (with all the ownership and tax complications that brings), or pull the RMD from other IRAs. Plan for RMDs before you lock capital into illiquid assets, not after.

Fraud Risks Specific to These Accounts

The SEC, FINRA, and state securities regulators have issued joint warnings about fraud aimed at self-directed IRA investors. The vulnerability is structural: custodians don’t investigate investments or vet promoters, and fraudsters exploit the gap between what investors assume the custodian checked and what actually happens.¹¹

Common schemes include promoters who falsely suggest the custodian has approved or validated an investment, fake custodians who take deposits and disappear, and Ponzi-style private placements that count on the early-withdrawal tax penalty to keep investors from looking too closely. The SEC specifically warns that using a legitimate custodian to buy an investment does not make that investment legitimate.¹¹

Before committing funds, confirm the custodian is a real, regulated entity. Check the promoter through FINRA BrokerCheck and SEC EDGAR. Get independent valuations. If anyone tells you the custodian has “approved” a deal, treat it as a red flag. Custodians don’t approve deals.

1
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
2
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
3
Internal Revenue Service. Investments in Collectibles in Individually Directed Qualified Plan Accounts
4
Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
5
Internal Revenue Service. Retirement Topics – Prohibited Transactions
6
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
7
Internal Revenue Service. Topic No. 413, Rollovers From Retirement Plans
8
Internal Revenue Service. Instructions for Form 990-T
9
Internal Revenue Service. 2026 Form 1041-ES
10
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
11
U.S. Securities and Exchange Commission. Investor Alert – Self-Directed IRAs and the Risk of Fraud