Determine the Option That Best Aligns with Your Investment Goals
Experienced investors and real estate professionals are aware that real estate can be a cornerstone of their IRAs. Real estate is an asset that adds diversity to account holders’ retirement portfolios. Account holders can find a reprieve from the volatility of the stock market by investing their IRAs in rental properties like houses, commercial real estate, condos, townhomes and duplexes. Investors can use their favorite investment strategies and their IRA money for rentals, fix-and-flip projects, land speculation and more.
Once retirement investors reach the age of 59.5, they are able to take distributions from their IRAs without incurring the 10 percent early withdrawal penalty. The time leading up to this milestone is often when investors take the opportunity to strategize how the real estate will be distributed from their retirement accounts.
There are a number of distribution strategies available to IRA real estate investors. The trick is for investors to know which options are available to them, and which choices will best align with their personal investment goals. Keep in mind, you can be the source of knowledge and inspiration for not only your own retirement strategies, but also those in your network who are looking to invest their IRAs into real estate.
The first consideration that IRA real estate investors may take into account when devising a distribution strategy is their personal income tax rate. If they believe they will be at a higher tax rate when they reach the age of distribution, it may be beneficial for the client to invest in real estate with a Roth IRA, as Roth contributions are taxed upon going into the account, and not taxed upon distribution. On the contrary, if real estate investors believe they will be in a lower tax bracket upon distribution age, investing in real estate with a Traditional or SEP IRA may be the best route, since contributions are taxed upon distribution.
Collect Rent With Tax Advantages
If part of your investment goal is to hold real estate for passive income, you can continue to rent the IRA property and collect rental income. One of the main reasons investors turn to IRA real estate is so rental income can go back into the IRA and stay under the tax umbrella. Account holders don’t have to pay taxes on their rental income until they need it and therefore have additional control over their taxable income.
Selling IRA Property
Another option available to account holders is to sell the IRA property, in which case the cash proceeds go back into the IRA, which can then be taken as a distribution. Traditional IRA holders will have to pay tax on the cash amount they take as a distribution. With a Roth IRA, these proceeds will be tax-free, as long as the five-year rule is satisfied on gains.
In-Kind Distributions
IRA holders have the ability to distribute the ownership of property “in-kind” by retitling the deed from the IRA to the account holder personally (the initial titling of the property is in the name of the IRA, not the individual). This means never losing control of the property; there is simply a change of ownership.
If the property was purchased with a Roth IRA, account holders will be able to make a qualified distribution of the property without having to pay taxes on that distribution. If it was purchased with a pre-tax plan (Traditional, SEP, etc.), the owner will have to pay taxes on the appraisal value of the property upon time of distribution.
At this point, account holders are free to use the real estate as a primary residence or a vacation home. Before completing full distribution of the property, the IRS disallows account holders and all other disqualified persons from residing in or having personal use of an IRA investment property.
If the property was previously held within a pre-tax plan, it was collecting rent at a tax-deferred rate. Once the property is distributed from the pre-tax plan, and the owner wants to continue renting the property, the rent will be taxed at the account holder’s personal tax rate. If the property was held in a Roth IRA, the account holder cannot continue to collect tax-free rent after the property is distributed from the account, and the tax benefits are lost.
Avoid UBIT
If the account holder used debt-leverage (i.e., a mortgage) to purchase the IRA’s real estate, he or she may incur UBIT, or unrelated business income tax, on the debt-leveraged portion of the profits. However, once the account holders pay off their IRA’s loan and the debt ratio calculates to zero (by averaging the last 12 months), he or she will no longer have to pay UBIT on any of the profits.
Avoid Recapturing Depreciation
Depreciation is an appealing tax incentive for real estate investors and looks a little different inside an IRA versus outside an IRA. When you purchase property outside an IRA, depreciation is a tax-deferral mechanism in as much as you must pay tax on unrecaptured depreciation of the property upon the sale of the home. A little-known detail about depreciation and debt-leveraged IRA real estate is your IRA can avoid paying tax on the depreciation that your IRA benefited from in prior years by paying off the loan 12 months prior to the sale.
Planning for RMDs
In terms of generational wealth, required minimum distribution (RMD) rules are important for investors to remember when planning for the future of their investments. If a Traditional IRA account holder wants to avoid chipping away at his or her account by taking RMDs after reaching 70.5 years of age, the account holder can make a Roth conversion before that time. However, he or she will have to pay taxes on the conversion amount, so account holders will want to consider their current tax rate before making this change. Roth account holders can liquidate or continue to rent or sell their IRA properties tax-free throughout the account holder’s lifetime without ever having to take an RMD.
Don’t Rely on Social Security Income
Social factors also play a role in retirement investors’ future planning. Social Security has been on a path of decline, making it ever more critical for Americans to secure a second source of income for their retirement. Real estate can be a lucrative resource for investors to make money for their retirement years.
Self-directed IRA real estate investing is becoming more and more popular. While real estate is an asset that many account holders are familiar with, knowing and understanding the many distribution strategies associated with this investment can help investors make the most of their retirement.
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