Holding private real estate inside a self-directed IRA

A self-directed IRA can hold a private real estate interest. That is the part most people ask about, and the answer is yes. The harder question is whether it should hold this kind of interest, and that turns on what you were buying the deal for. What follows is mechanics: what the tax attributes of a development deal are worth inside the account, and the three places it makes work the owner did not expect. It is written by the firm that develops and operates the buildings it raises capital for.

What a self-directed account can hold, and who signs

“Self-directed” describes where the account is held, not what the tax code lets it do. A brokerage built for listed securities will not hold an asset that does not trade. A self-directed IRA sits at a custodian or trust company that will: private fund interests, notes, direct property. The custodian is the part that changes.

The consequence appears at subscription. The investor is the account, not you. The custodian executes the subscription documents at your written direction, the account’s name goes on the register, and the money leaves the account rather than your bank. Distributions come back to it, and the K-1 is issued to it, not to you.

That adds a second signature to every capital call and every consent, on the custodian’s schedule rather than yours, and sponsors differ in how readily they accommodate it.

Depreciation has no income to reduce inside the account

A new building generates a large deduction in its early years, accelerated by a cost segregation study and by bonus depreciation on the short-lived components, and no cash leaves the project to produce it. That chain, through to what is recaptured at sale, is set out in our article on why development deals produce paper losses.

A tax-deferred retirement account cannot use any of it.

The reason is structural. A deduction is worth something because it reduces income that would otherwise be taxed this year. Inside the account there is no current tax on that income, so the deduction has nothing to reduce. The loss arrives and stops, never reaching your return, so there is nothing for the Section 469 machinery to do. Outside an account those rules are the whole question, and for a salaried investor the answer is that a passive loss cannot reach W-2 wages — it waits for passive income or for a fully taxable exit.

Nor is there a capital gain rate inside the account, so converting ordinary income into long-term gain at exit buys nothing either. What the account earns is taxed, if at all, on distribution, and from a traditional account at ordinary rates whatever produced it. The feature most investors are buying is the one the account switches off.

Debt-financed income inside a retirement account

The second issue cuts the opposite way. A retirement account is generally exempt from tax on its investment income, and the exemption is not unlimited: income an exempt account earns from a trade or business regularly carried on can be unrelated business taxable income (UBTI), taxable to the account in the year it arises.

The branch that matters here is the debt-financed one. Where an account holds property acquired with borrowed money, the share of income attributable to that borrowing can be unrelated debt-financed income (UDFI), taxed to the account. Development is financed by design: a construction loan is not an enhancement, it is how the building gets built. So part of what the account receives may be taxable inside a vehicle its owner thinks of as sheltered.

The tax is paid from the account, reducing the balance that was supposed to be compounding, and the account may acquire a return of its own on Form 990-T, signed by the custodian at your direction. Custodians charge for that. The thresholds belong to the CPA who prepares your return, asked before you subscribe.

Prohibited transactions and disqualified persons

Custody is not freedom. The prohibited transaction rules restrict dealings between the account and the people connected to it — the beneficiary, certain family members, entities they control, fiduciaries to the account — collectively, disqualified persons. The restrictions are broader than intuition suggests.

• The account cannot buy an asset from a disqualified person, or sell one to them.
• It cannot lend to one or borrow from one.
• Its assets cannot be used to benefit one personally, and property it owns cannot be used by one.
• The beneficiary cannot be paid for services performed on those assets.
• Guaranteeing a loan made to the account can itself be a problem.

A misstep is not scored as a penalty on the transaction that went wrong; it can disqualify the account and treat the entire balance as distributed. For a genuinely passive fund investment most of this is remote. It becomes live wherever there is a connection between investor and sponsor, a service performed, a personal use, or a related party. That is counsel’s question, before the subscription.

Illiquidity meets required distributions

Private real estate is illiquid, and both funds we run publish liquidity as illiquid alongside a targeted hold measured in years; the terms are on the funds page, summarised from the offering documents and qualified by them. There is no secondary market for interests of this kind, and a redemption right, where one exists, is a term in a document rather than a property of the asset.

Set that against an account that may be required to pay out. A traditional IRA becomes subject to required minimum distributions (RMDs) once the beneficiary reaches the age the rules set. The account has to distribute; the asset may not be sellable to fund it, and a fractional interest in a private fund is an awkward thing to distribute in kind.

A Roth account changes that half of the analysis: no required distributions in the owner’s lifetime, so the collision does not arise in the same way. The debt-financed income question applies to a Roth exactly as it does to a traditional account.

Accreditation when the account is the subscriber

Our offerings are available to accredited investors only and are made under Rule 506(c) of Regulation D, which requires that accredited status be verified rather than self-certified; the investor page says what to expect. Subscribing through an account does not route around that. Where an IRA is the subscriber, the qualifying facts are generally those of the person the account belongs to rather than the custodian holding it, but confirm the route with the sponsor and your own counsel before the paperwork starts.

When it may still make sense

None of this says a retirement account is the wrong home for private real estate. The narrower claim is that the tax attributes which make development equity distinctive are spent on nothing in there. Two situations run the other way, both questions for a CPA.

A debt position rather than an equity one. Interest is ordinary income, taxed in the year it is paid. A loan carries none of the depreciation a retirement account cannot use, so nothing is wasted by holding it inside one, and sheltering ordinary income from annual tax is close to what the account is for. The debt-financed question above still has to be asked. The difference between lending and owning is set out under the two ways capital participates.

An investor whose taxable capacity is already committed. A loss is only worth something to someone with income of the right character to absorb it. An investor who cannot use another passive loss this year gives up less inside an account than the headline suggests: nothing passive left to shelter, or earlier suspended losses already waiting for a disposition.

The comparison that decides it

The after-tax calculator runs the arithmetic: the same dollars in a taxable account, where the losses may be usable and part of the gain at exit is capital, against the same dollars inside a retirement account, where neither applies but nothing is taxed until it comes out. It treats other passive income as the single biggest factor, because that one fact decides whether the losses help you now or sit unused until the property sells, and it shows its working. What it cannot model is your account or your custodian’s fees. The guide to investing in Ohio multifamily real estate covers how these investments are put together, and the communities map shows what the capital builds.

Questions worth asking before you direct an account

• Will the sponsor accept a subscription from a custodian, and who signs each document?
• Does the structure produce debt-financed income for an exempt account, and what would that cost in a normal year?
• Who prepares the account’s own return if one is required, and what does the custodian charge for it?
• Is there any connection between you, your family, or a business you control and the sponsor or the property?
• Where does the annual valuation the custodian has to report come from, and on what basis?
• If a required distribution falls due while the interest is still held, what in the account pays it?

Those are questions for the offering documents, the custodian’s agreement, and your own CPA. Our investor relations team will take the ones that are ours to answer.

This is general information about how these accounts work, not tax, legal, or investment advice, and not a recommendation about your account. Outcomes depend on the type of account, the terms of the investment, how the project is financed, and facts specific to you, and tax law changes. Private real estate is illiquid and speculative, no return is promised, and investors may lose some or all of their capital. Before directing an account into one, ask your own CPA and the custodian who would hold it.