Self-Directed IRA: What the IRS Allows and How to Stay Compliant

What Is a Self-Directed IRA?

A self-directed individual retirement account gives you control over investment choices beyond stocks, bonds, and mutual funds. The IRS permits alternative assets such as real estate, private mortgages, tax liens, and certain precious metals inside these accounts. The account holder makes decisions, but a custodian or trustee must administer the IRA and file required reports with the IRS.

Self-direction does not create a separate tax regime. The IRS taxes self-directed IRAs under the same rules that apply to all traditional and Roth accounts, including contribution limits, required minimum distributions, and distribution taxation.

IRS Rules for Self-Directed IRAs

The Internal Revenue Code sets the boundary for what is allowed inside a self-directed IRA. The custodian must follow IRS instructions on reporting, valuation, and distribution. Account owners must comply with IRS rules on disqualified persons and prohibited transactions.

Contribution Limits

The IRS sets annual contribution limits for all IRAs, including self-directed accounts. For 2024, the limit is $7,000 for individuals under age 50 and $8,000 for those 50 and older. These limits apply across all your IRAs combined, not per account.

Required Minimum Distributions

Traditional self-directed IRAs require required minimum distributions starting at age 73, as updated by the SECURE 2.0 Act. Roth self-directed IRAs are not subject to lifetime RMDs for the original owner. The IRS treats distributions from self-directed IRAs the same as from any other IRA, based on the account's fair market value at the time of withdrawal.

Prohibited Transactions

The IRS prohibits certain transactions between an IRA and a disqualified person. Disqualified persons include the account holder, the account holder's spouse, ancestors, lineal descendants, and entities they control. Prohibited acts include using IRA assets for personal benefit, selling property to your IRA, and receiving personal benefit from IRA income.

Allowed Investments in a Self-Directed IRA

The IRS does not maintain a list of approved investments. Instead, it defines what is prohibited. Common alternative investments held in self-directed IRAs include:

• Real estate, including rental properties and raw land
• Private mortgages and promissory notes
• Tax lien certificates
• Private equity and LLC membership interests
• Certain precious metals meeting IRS fineness standards
• Cryptocurrency, depending on the custodian

Assets must be held for retirement and must not provide a personal benefit to the account holder or a disqualified person before distribution.

Prohibited Assets and Actions

The IRS explicitly bars certain assets from IRAs, including collectibles such as most artwork, rugs, antiques, metals not meeting purity standards, and certain coins. Life insurance contracts are also prohibited inside IRAs. The IRS also prohibits transactions such as borrowing money from your IRA, selling property to your IRA, or using your IRA as security for a personal loan.

Custodian and IRS Reporting Requirements

A self-directed IRA must be established and maintained by a qualified custodian. The custodian reports contributions, conversions, and distributions to the IRS on Form 5498 and 1099-R. The custodian must also ensure that the IRA's alternative assets are properly valued and reported. Failure by the custodian or the account holder to follow IRS reporting rules can result in penalties or disqualification of the entire account.

Tax Treatment and Compliance

Traditional self-directed IRAs offer tax-deferred growth, with contributions potentially deductible depending on income and workplace plan coverage. Roth self-directed IRAs provide tax-free growth and qualified distributions. The IRS taxes early withdrawals from traditional self-directed IRAs as ordinary income and may impose a 10% penalty for withdrawals before age 59½, with some exceptions. Compliance depends on following IRS rules on prohibited transactions, accurate reporting, and proper custody of assets.

How to Open a Self-Directed IRA

To open a self-directed IRA, choose an IRS-approved custodian that supports alternative assets. The custodian will establish the account, accept contributions or rollovers, and execute transactions according to IRS instructions. The account owner directs investments, but the custodian holds title and ensures compliance with IRS reporting and prohibited-transaction rules.