You might not know that in addition to the typical investments in stocks, bonds, and mutual funds, you’re allowed to hold almost any type of asset in your retirement account (with the exception of collectibles, precious metals, and life insurance.) Holding real estate in IRAs is a great option for many investors.
Tax Benefits To IRAs
The 2013 surtax on investment income added even more incentive to consider utilizing your retirement plan as a vehicle to hold your investments in income-producing real estate. Under the law, any passive rental income (as well as interest, dividends, capital gains, etc.) became subject to an additional 3.8% tax for taxpayers with modified adjusted gross income (MAGI) in excess of $250,000.
Distributions from your retirement accounts are treated as ordinary income and exempt from the 3.8% tax.
Why And How To Contribute Real Estate
If you wanted to take this theory a step further, you could consider purchasing real estate through a self-directed Roth IRA to receive tax-free income for life using after-tax dollars. Those familiar with Roth IRAs might be thinking, “What if I make too much money to contribute to a Roth IRA?” or, “How can I buy real estate when I can only contribute $5,500 per year?”
While this used to be a problem, the law now permits taxpayers with any level of income to convert almost any tax-deferred account such as a traditional IRA, SEP, Keogh, or 401(k) into a Roth IRA.
If you choose to convert a qualified account, any pre-tax dollars in the account are subject to tax at the time of the conversion. In many cases, this will be the entire value of the account. This ultimately allows you to holding real estate in IRAs.
Converting A 401(k) to a Roth IRA
The prospect of paying the tax now to convert the account might be expensive, but the trade-off of paying tax now for a future stream of tax-free income is attractive to many investors, particularly for the younger taxpayers that will be working for many more years. That being said, if tax rates increase by the time you retire, you win even more!
There are strict restrictions and regulations about the financing and management of properties used in this manner. The specific rules are beyond the scope of this article, but if you don’t follow them, you’ll incur certain taxes and penalties. This tax strategy should be reviewed by both your CPA and financial advisor. If it works for your situation, you could save a lot on your tax bill both short-term and long-term.
Call me for assistance if you think this might work for you, but aren’t sure. Have you ever done this type of financial planning before? Have you considered investing in real estate for retirement purposes before?
By: Ben Hubbell, CPA
Partner
Ben Hubbell is a leader in WHH’s real estate practice group. His expertise in complex transactional consulting, pass through entities, and tax deferred exchanges has been honed over his 12 years at the firm. Ben has a particular talent for interpreting and utilizing various applications within the increasingly complex tax code. He has been an integral part of our research team regarding the new tax laws and specifically Qualified Opportunity Zones.
