7 Reasons to rethink a self-directed IRA (SDIRA)

Self-directed IRAs (SDIRAs) have been around since the 1970s—almost as long as the traditional IRA. But while typical IRAs hold stocks and mutual funds through familiar custodians like Fidelity or Schwab, SDIRAs let you invest in:

  • Real estate
  • Private businesses
  • Cryptocurrency
  • Precious metals
  • And other alternative assets

This flexibility is powerful—but also risky. SDIRAs come with extra rules, tax traps, and compliance burdens most investors aren’t prepared for.

If you’re considering one, here are 7 risks and complications to be aware of:

1. You’re on your own. Custodians don’t advise or protect you.

SDIRA custodians don’t give legal or tax advice. They just hold the assets and follow your instructions.

That means you’re responsible for avoiding IRS violations—often without knowing the rules.

Common pitfalls:

  • Personal loan guarantees (even on property held in the IRA) can disqualify the entire account.
  • Sweat equity—like painting a rental or fixing a toilet—can be a prohibited transaction.

These mistakes are easy to make—and the penalties are severe.

2. You may still owe taxes inside your IRA.

Yes, IRAs are tax-deferred—but not always with SDIRAs. Two tax traps to watch:

  • Unrelated Business Income (UBI):
    Earned by operating businesses inside your IRA (e.g., car washes or laundromats).
  • Unrelated Debt-Financed Income (UDFI):
    Generated when you buy an asset with debt (like a mortgage on rental property).

The problem?
UBI and UDFI are taxed at trust tax rates—which hit 35% once income exceeds $11,150 (as of 2024).

3. Estate planning gets messy.

Passing along alternative assets is harder than passing along stocks.

Your heirs may:

  • Need to maintain illiquid assets they don’t understand
  • Have to pay for appraisals, legal filings, or trust accounting
  • Face tax complications if assets aren’t handled correctly within two years of your death

4. Your money could be locked up for years.

Many alternative investments are illiquid by nature—think real estate, startups, or private funds.

If you or your beneficiaries ever need to sell quickly, you may be stuck.

5. You’re responsible for annual valuations.

The IRS requires all IRA assets to be valued every year. For alternative investments, this means:

  • Hiring a qualified appraiser
  • Paying for reports or audits
  • Handling extra tax preparation fees (especially if there’s UBI/UDFI income)

6. Roth conversions get complicated.

If you plan to convert to a Roth later, SDIRAs can block or delay your strategy.

Here’s why:

  • The IRS applies the pro rata rule across all IRAs
  • Illiquid or hard-to-value assets can distort your conversion math
  • You may be stuck with ongoing tax and accounting headaches for years

7. SDIRAs increase your audit risk.

Because of their complexity and abuse potential, the IRS keeps a close eye on SDIRAs.

Promoters love to advertise SDIRAs as the “ultimate alternative investment tool”—but they won’t be around to help if you make a costly mistake.

Bottom Line

Self-directed IRAs can be powerful in the right hands—but they’re not beginner-friendly.

If you’re not well-versed in tax law, IRA rules, and investment compliance, you’re better off sticking with traditional strategies—or working with a qualified expert.