The Downside of Investing with Self-Directed Individual Retirement Accounts (SDIRA)

Updated: Jun 22




Downside #1 – Unrelated Debt-Financed Income (UDFI)

Unrelated Debt-Financed Income (UDFI) can occur when any property held within a Self-Directed Individual Retirement Account (SDIRA) produces income. Therefore, if you use a loan to purchase properties in your SDIRA, then the income produced from the financed asset will be subject to UDFI income tax--even though we may never actually receive payment from them! Any gains from such property are indebted at any time during the tax year. This triggered penalty can happen with corporate stock, tangible personal property, and real estate. It's always best to consult with a qualified intermediary or financial tax advisor knowledgeable about UDFI before investing in any asset, so you are aware of (and can plan for) any potential indebtedness due to UDFI.

Downside #2 – Third-Party Involvement

As previously mentioned above, to take advantage of the SDIRA benefits, you will need to hire a third-party custodian to administer your self-directed retirement account. The IRS requires the involvement of a certified IRA custodian to hold the account. Any investments must be approved by your custodian – including the release of funds. The custodian is responsible for tracking your account transactions to report to the IRS. This could potentially slow down your turnaround in time-sensitive situations when you need to have cash at your fingertips.

Downside #3 – Restrictions and Possible Disqualification

Taking control of your investments carries a great deal of risk and responsibility. This means account holders must perform their due diligence and follow the rules rigidly to avoid any penalties. For instance, you cannot use your IRA-owned property, nor can any disqualified individuals who may eventually benefit from your savings. You cannot be involved with the investment or use personal money to improve upon it. You cannot benefit from your real estate investment until after retirement. As you look into your options, be careful and secure your investments.

Bottom Line for Real Estate Investing with a Self-Directed IRA

When you plan to invest in real estate using an SDIRA, you need to know that it requires patience, careful planning, and the funds to secure your assets. The choice to ultimately begin investing in real estate with an SDIRA is a decision only you can make. To get guidance around this, you can enlist the help of your tax & legal team and a Qualified Intermediary / IRA Custodian. A qualified intermediary is a neutral third-party responsible for holding and administering eligible retirement accounts. If you have determined that real estate is the suitable asset class for your SDIRA, your first step is to schedule a time to speak with a good Qualified Intermediary. One such company is the eQRP company. Other well-known third-party SDIRA custodians include the Quest Trust Company and Horizon Trust.

BREAKING NEWS Regarding Checkbook IRAs - Now Illegal as of November 18, 2021


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