Pros & Cons of Self-Directed IRAs in Real Estate Investing


Key Takeaways

  • A self-directed IRA is a specific type of retirement account that allows investors to allocate capital to non-traditional investments – like commercial real estate 
  • The benefit of using a SDIRA to invest in real estate is that it can allow funds to grow tax free over time, boosting retirement savings.
  • However, there are strict rules that must be followed to ensure that investment transactions do not become taxable.

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Pros & Cons of Self-Directed IRAs in Real Estate Investing 

Self-Directed Individual Retirement Accounts (SDIRAs) can be an effective way to diversify retirement investments because they allow individual investors to invest in alternative assets that are normally excluded from regular IRAs. But, they can also be confusing for many investors.

In this article, we will discuss what SDIRAs are, how they work, and the benefits and drawbacks associated with SDIRA investments. By the end, readers will have all the information needed to determine if investing in real estate through an SDIRA is a good fit for their investment strategy.

First National Realty Partners is a private equity commercial real estate investment firm that specializes in the purchase and management of grocery store-anchored retail centers. If you are an accredited investor and would like to learn more about our current opportunities, click here.

What is a Self-Directed IRA?

An SDIRA (self-directed IRA account) is a type of retirement account / retirement plan that can hold various alternative investments normally excluded from regular IRAs (like commercial real estate). These investments are self-directed because although an IRA custodian administers the account, it is wholly managed by the account holder. 

Advantages of Using a Self-Directed IRA in Real Estate Investing 

There are several benefits to using an SDIRA to invest in commercial real estate investment properties. They include tax savings, the ability to own shares of an LLC in the account, asset control, and high potential return on investment (ROI). In addition, investors enjoy the peace of mind created by creditor protection and portfolio diversification. 

There are two ways to set up an SDIRA for real estate investment purposes, a Roth SDIRA or Traditional SDIRA. In a Roth SDIRA, funds are contributed after tax, while funds are contributed pre-tax in a traditional IRA. Other than this difference in tax treatment, they offer the same benefits.

Tax Benefits 

SDIRA investments create tax benefits for investors because all income and capital gains generated within them can grow tax-free, regardless of how the self-directed account is set up. However, investors must be careful not to partake in a prohibited transaction, or they may find that a portion of their retirement funds become subject to income taxes.

Roth Self-Directed IRAs

For a Roth SDIRA, the contributed funds are still considered earned income and are subject to taxes at the time of investment. However, once the taxes are paid, the funds will grow tax-free in the account and may be withdrawn at retirement tax-free.

Traditional Self-Directed IRAs

If the account is set up as a Traditional SDIRA, the contributions are tax-deferred. This means taxes will eventually have to be paid, but not until retirement. The benefit here is that most retirees will be in a significantly lower tax bracket when it is time to withdraw their funds.

Opening an LLC

Investing through a Limited Liability Company (LLC) is an investment strategy that is allowed for self-directed real estate investors. Under this strategy, an investor establishes an LLC and names the SDIRA as the owner. This LLC can then invest in alternative assets like real estate. There are a few major benefits of investing through an LLC:

  • Reduced fees if the SDIRA provider charges fees per asset. This arrangement gives account holders the ability to invest in multiple assets that are all part of one LLC.
  • Reduced transaction fees because the SDIRA provider will not need to cut checks for the management of assets. 
  • Liability protections for investors.
  • Can give the SDIRA account holder the ability to have “checkbook control” over the SDIRA funds, which results in the ability to complete transactions more quickly.

Asset Control 

SDIRAs can hold almost any type of investment except for life insurance and collectibles. This means an individual can use an SDIRA to invest in every type of real estate, including commercial property. However, investors should be aware of the strict rules that govern these investments by familiarizing themselves with IRS Regulations.

High Potential ROI

Because SDIRAs provide the freedom to invest in nearly every type of asset, investors have the opportunity to invest in assets that historically provide higher rates of return. For example, when comparing historical REIT performance to the stock market, some investors find that real estate assets can outperform traditional financial assets like stocks and bonds. It’s important to note that real estate investments can produce gains for investors in two ways – by generating rental income and through property appreciation.

Creditor Protection

As a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, SDIRA retirement accounts of up to $1 million are protected from creditors. This is not true in standard real estate investments.  Creditor protection is an advantage to investors because, in the event of a bankruptcy event, investors may find that SDIRAs make it difficult or impossible for creditors to seize assets held within the account. This is one of the key features that distinguishes investing directly in real estate versus investing in real estate through an SDIRA. 


One of the bedrock principles of investment risk management is diversification. This principle advises investors to spread their capital among many different types of investments, so that returns (or losses) are not overly dependent on any one.

A typical IRA investment portfolio holds two traditional investment asset classes, stocks, and bonds (often through mutual funds). But, an SDIRA allows investors to allocate capital to alternative investments, like real estate, which increases the diversification of a portfolio, further reducing risk over time.

Potential Drawbacks of Self-Directed IRA Investments

Although investing in real estate through an SDIRA can create some major benefits, investors should also be aware of the potential drawbacks. Some of the most prominent are described below.

Initial Cost

SDIRAs with “checkbook control” have higher initial setup costs but no transaction fees. As discussed above, “checkbook control” is simply a premium paid upfront that gives investors a greater ability to buy and sell real estate holdings in the portfolio regularly without being subject to transaction fees. This type of SDIRA is better suited for investors looking to invest actively.

Custodian Involvement & Fees

Custodial SDIRAs have a low setup fee, but charge fees for every transaction. These types of SDIRAs are better suited for investors seeking to invest in fewer properties, and require less management of the account. The drawback of this approach is that transaction fees can add up quickly if an investor moves to a more active investment strategy.


Investing in commercial real estate is a less liquid form of investment than investing in stocks and bonds. Therefore, if an investor wants to sell a property in the portfolio, it will take longer to receive the cash when compared with traditional retirement investments.


Investors placing funds into traditional retirement accounts don’t usually need to dedicate a substantial amount of time to actively managing their portfolios. However, investors using SDIRAs with “checkbook control” must regularly monitor their portfolios, which can lead to a hefty time commitment. 

Debt-Financing Income 

When using SDIRAs for investments in real estate, the percentage of profits subject to taxation is determined by the percentage of the property that is debt-financed. Therefore, if an investor acquires a non-recourse loan for an SDIRA investment, unrelated business income tax (UBIT) applies. This is a drawback in that the higher the debt on a property, the greater the amount of funds subject to taxation.

Regulation Compliance 

SDIRAs have strict regulatory oversight by the Internal Revenue Service (IRS) and are governed by the Internal Revenue Code (IRC) Section 408. Therefore, a drawback to investing in real estate through an SDIRA is understanding and complying with the many regulations. For example, if an investor uses an SDIRA to invest in rental properties, and stays in one of those properties for even one night, the entire self-directed IRA may be subject to applicable taxes and withdrawal penalties.

Market Fluctuations 

Like any investment, an investor risks losing money due to circumstances out of their control. The real estate market is cyclical, and an SDIRA with a large proportion dedicated to real estate holdings can suffer if real estate values decline substantially. However, SDIRAs are longer-term investments, and investors will usually see a return on investment time.

Loss of Tax Benefits 

As discussed in this article, investing with an SDIRA provides tax-free growth for gains and substantial protection against creditors. However, there is a loss of tax benefits when compared to regular real estate investments. Namely, direct investments in real estate (outside the scope of an SDIRA) enjoy the benefit of depreciation, which allows investors to take a tax deduction to account for the wear and tear on the property.  Income generated by properties held in SDIRAs is not subject to taxation while held in the account, so investors cannot claim deductions for depreciation.  In fact, properties held in SDIRAs are not eligible for other common tax deductions either, including – property taxes and mortgage interest.

Summary of the Pros & Cons of Self-Directed IRAs in Real Estate

As discussed in this article, SDIRAs provide a solid avenue to buy real estate due to the benefits investors obtain through tax-free growth. However, there are many regulations that govern these accounts, setup costs and fees can be hefty, and liquidity issues often arise.

To determine if an SDIRA is a good fit for an investor’s strategy, individuals should perform the necessary due diligence to ensure that they will benefit from all of the tax advantages they have to offer. It may also be a good idea to speak with a financial advisor to help make these important investment decisions.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you are an Accredited Real Estate Investor and want to learn more about our investment opportunities, contact us at (800) 605-4966 or for more information.

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