Ask around about self-directed IRAs and you'll hear a lot of confident answers. Some are right. Plenty are wrong. Here's what's true, and the real risks worth your attention.
Myth 1: "Setting one up is hard."
False. You open an account with a self-directed IRA custodian, the same way you'd open any IRA. Most big banks and brokerages don't offer them, so you'll use a specialty custodian. They'll walk you through it, and you can fund it by transferring from another IRA or rolling over an old 401(k). Here's how the rollover works.
Myth 2: "An IRA can't own real estate."
False. The IRS lets IRAs hold real estate, private loans, and mortgage notes. Most brokerages just don't offer them. A self-directed IRA is still a traditional or Roth IRA. It simply uses a custodian that allows these investments.
Myth 3: "You need an LLC."
Only sometimes. An LLC is only needed for a "checkbook control" IRA, where the IRA owns a company you manage. A regular self-directed IRA works fine without one, and you still need a custodian either way. To lend on notes, you don't need an LLC.
Myth 4: "My custodian will tell me if a deal is bad."
False, and this one costs people money. A custodian holds your assets and processes paperwork. They don't judge whether an investment is sound, and they don't watch for fraud. Checking out the deal is on you.
Myth 5: "It's my money, so I can use my IRA to buy a house I'll use."
False. Your IRA can't do deals that benefit you, your spouse, your parents, or your kids right now. No vacation home you stay in. No loan to your own business. Break that rule and the IRS can treat the whole IRA as withdrawn. See the rules.
The real risks
- Fraud. Scammers know self-directed IRA owners have money and no one checking their deals. Vet anyone who wants your IRA money. My free lender guide has the questions to ask, including of me.
- Breaking IRS rules. Prohibited transactions can make the whole account taxable, plus penalties. Learn the rules before you invest.
- Losing money. Any investment can go wrong. Real estate and notes are no different.
- No built-in adviser. Nobody is required to look out for you. Bring in a CPA or attorney you trust.
- Less liquidity. You can't sell a note or a property with one click.
The bottom line
A self-directed IRA gives you real freedom, and the rules are there for a reason. If you want the benefits without being the one who finds and checks every deal, your IRA can lend to an experienced operator who does the work while your money stays in your IRA.
General education, not tax, legal, or investment advice. IRA rules are strict and change over time. Talk with your custodian and a CPA or tax attorney before you invest. All investing has risk, including loss of principal.