A self directed IRA allows an investor to invest in real estate in an IRA account. The IRS code restricts investments in IRA accounts, and certain investments are prohibited (such as art, antiques, S-corp stock, life insurance, and collectibles). Investment real estate is allowed, however, as long as the participant is not benefiting from the real estate in any way. In order to qualify under IRS rules the participant may not use the property in any manner, or receive rental income from the property outside of the IRA.
To invest in real estate, typically the IRA participant must designate a financial institution, in the majority of cases a trust company, as the trustee and custodian of the self directed IRA account. The IRA participant can then direct the trustee to purchase real estate for the IRA. All real estate expenses must be paid from the IRA account, and all income from the real estate must be paid directly back into the IRA account.
As long as the self directed IRA is set up correctly and is compliant with IRS rules, the IRA participant is able to enjoy the tax advantages of the IRA. This includes tax deferral of both the income received from the property as well as capital gains received when the property is sold. In the case of a ROTH IRA, the participant is also entitles to receive tax free withdrawals, assuming that the normal requirements are met.