Benjamin Franklin made famous the statement; “In this world, nothing can be said to be certain, except death and taxes.” Perhaps today we could add: “and tax increases” based upon the health care law that will be instituted in the coming years and the government “adjusting” our income tax structure.
Surely with taxes on the rise, 401Ks, traditional IRAs and Roth IRAs will become even more important to your tax planning and retirement strategy.
A traditional IRA allows a tax deduction for the money you invest and returns accumulate tax free until you make a withdrawal.
Roth IRAs do not give you a tax deduction at the time of investment, however, money invested accumulates tax free and your withdrawals are tax free once you reach 59-1/2 subject to certain restrictions.
A self-directed IRA is becoming more popular because it allows investment in non-traditional investment vehicles such as gold and real estate. Many of my friends have used self-directed IRAs to invest in real estate and they are having good success and obtaining returns of 7 percent to as high as 14 percent, however, there are no guarantees. If you buy a rental property with a self-directed IRA you must have a custodian who oversees the account. There are rules and restrictions you must follow so you do not trigger a taxable event. A custodian and your accountant can apprise you of the specific rules.
Let’s look at a scenario where you put a rental property into a self-directed IRA. A property generates $1,000 a month in gross rental income. After expenses you net $800. If you are under 59-1/2 years of age, you must let the income accumulate in the IRA to avoid potential tax or penalty consequences. After 59-1/2 you have some choices. You may sell the property and take the proceeds. You may take out the rental income to supplement your income or you may let the income accumulate to the point where you can purchase another property in the IRA which will generate more income.
In a traditional IRA your proceeds will be taxable at withdrawal, however, in a Roth IRA the proceeds will be tax free.
With the deflated values in the housing market, there is the prospect of benefiting in many ways from the above scenario. You can receive income assuming the property stays rented and as the housing market continues to improve, you may receive capital appreciation on the property.
This article cannot cover all the nuances, benefits, or pitfalls of this type of investment and the differences between a traditional and Roth IRA. If it has sparked an interest, you need to consult, just as I have, with your financial adviser and accountant to discuss if this type of investment would be advantageous for you.
Ray Pugel is a designated broker for Coldwell Banker Bishop Realty. Contact him at (928) 474-2216.