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Use a Roth IRA If You Must Buy Real Estate Within Your IRA


You can buy real-estate within your IRA, but it’s best to have enough IRA money to buy without a mortgage. Some retirees can do this. This article explains why they should use a Roth IRA rather than a traditional (i.e. deductible contribution) IRA to do this.

Normal tax laws have always made real-estate a good tax shelter. Since real estate is generally purchased with a mortgage, tax laws allow you to deduct the annual mortgage interest as well as your town’s annual real estate property tax. Selling profits are taxed at long term capital gains rates. Owners who live in their property are can exclude up to $250,000 of gain if you’re single- and twice that if married.

Those that rent out their property for rental income can additionally depreciate their property yearly for a further annual tax deduction. This, along with the mortgage, property tax and maintenance expenses deductions, can actually shelter the rental income from tax and perhaps other income they receive too.

These tax benefits are often too advantageous to forego by buying and holding rental income property within an IRA – and certainly within the traditional IRA. IRA tax rules wipe out the typical real estate tax advantages mentioned above. All real estate deductions are eliminated. And, you can’t live in any property you own within your IRA.

Traditional IRAs only defer taxes on annual real estate rental income. And that, along with all other property gains, will be tax at your income rates when you withdraw them.

I think that Roth IRA tax rules offer a better alternative and are more competitive with the usual real estate tax advantages. That’s because all yearly earnings and withdrawals are tax free and there’s no minimum required distributions after turning 701/2 either – as there is with a traditional IRA.

Let’s consider the advantages for seniors who buy rental investment real estate within their Roth IRA when they invest in high rental income real-estate that will significantly appreciate over time.

First, they can pull their real-estate investment rental income out tax free for their annual use. A key advantage is that Roth withdrawals won’t produce higher taxation of their Social Security income – or loss of some of its benefits.

Second, seniors often don’t have a high income themselves. So, they don’t reap much for sheltering income that depreciation would present if bought outside the IRA. In fact, seniors receive social security income which is only partially taxed or not at all.

Third, when their Roth IRA real-estate investment values increase over the years they can do one of several options – all tax free. One option is to sell that real estate within their IRA and take out all the cash – in any amount tax free. Or, of course, they could do it all over again.

Another option is to take that real-estate out of the IRA for their own use. If they sell it sometime in the future, its basis for determining capital gains tax would be their total contributions to the Roth IRA for real estate purposes. Depreciation never took place.

Finally, they can leave the real-estate in the Roth IRA so their beneficiary can reap further appreciation of it. The beneficiary must follow required minimum distributions for inherited IRAs but whatever they do take out will be tax free.

You’ll need to hire an IRA custodian who will actually purchase and title it in the name of the IRA custodian for your benefit if you do intend on buying real estate within your IRA. Find someone who’s experienced.

Shane Flait helps you with your financial legal, tax, and retirement goals.
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