Archives For Tax Planning
The recent increases in the real estate market has sent more and more first time real estate investors to Drive Planning. One of the common questions that we receive is centered around purchasing real estate (either to flip or rental/buy and hold) inside of a Qualified Retirement Plan, such as an Individual Retirement Account (IRA) or other types of plans.
This is most common for those who do not have funds which are outside of their Retirement Plan. So, a better question is, Where else can I get funding for my real estate deal? There are numerous sources for funds if you know where to look, regardless of credit!
Let’s Take a Look at The Problem
For the remainder of this blog I want to focus on why purchasing real estate inside of an IRA is a poor idea.
An IRA is a tax shelter. Tax on the income is either deferred (Traditional IRA) or eliminated entirely (Roth IRA).
Rental real estate is an example of a type of real estate investment that can be a tax shelter on its own. Rental real estate often generates losses for tax purposes even when there is positive cash flow. This is because of the depreciation deduction that can be taken on the investment.
With proper tax and accounting, rental losses can be used to offset other income which effectively shelters that other income from income tax. This can result in significant tax savings.
If an IRA has rental losses, the IRA is generally not paying tax so there is no tax to shelter.
If an individual has rental losses, there is an opportunity to shelter other income, including W-2 or business income, from income tax. This results in not paying tax on that other income and those tax savings mean cash in your pocket.
Lastly, in retirement any proceeds from real estate inside of an IRA (Traditional) comes out as ordinary income!
In addition, these problems also come along with Real Estate purchased within an IRA/Qualified Plan:
- Lose 1031 Tax Free Exchanges
- Lose “Step Up in Basis” at Death
- No Capital Gains Tax Rates
- Potential Increase in Tax Rates
- Lose enjoyment/use of funds prior to age 59 1/2 (Proposed/Potentially to be age 70 1/2 in the future)
The Bottom Line
Our team at Drive Planning has over 250 years of experience with situations like we’ve described above; therefore we believe that the tax savings are too significant so the property should be purchased outside of a qualified plan. Let us help you to find the money.
We would love to assist you with any financial decision and making sure that you are coordinating it into your overall financial plan.
Tax planning and advice should be reviewed by your personal tax advisor. The staff at Drive Tax and Accounting and Tom Wheelwright, CPA contributed to this article.
An iconic venue familiar to many Atlantans appears to be moving. Smiths Olde Bar, known for hosting great bands, has been ordered to vacate their premises due to the building being placed on the market to sell. This highlights a conversation that many small business owners often choose to ignore. Leasing space vs Owning their property.
Owning the property that your business utilizes can be a great win for your personal wealth building and tax management.
A familiar dilemma that faces many start up businesses is knowing where to place their business and exactly how much space they will need. I certainly recognize the challenge here. Once these items have been ironed out; I encourage a business owner to begin taking steps to own the property that they inhabit. If you have never been through this process before I would encourage you to work with a well healed business consultant/ financial professional to help guide you through the process.
- How to Own the Property – Likely in a Limited Liability Corporation (LLC) for asset protection
- Consider a Cost Segregation Study – This allows you to properly manage the depreciation on the property. Creating potentially significant tax savings.
- Pay Yourself Rent – Another way to create tax advantages within your business.
- Avoid Paying Someone Else Rent! – This is a big one. Most importantly you maintain control over your business. Watch The Smiths Olde Bar Story.
- Retirement Planning – This property could become an income stream that funds your retirement, whether you own the business or not during that time of your life.
- Estate Planning – Owning Real Estate has advantages when you consider techniques to manage and mitigate Estate Taxes.
Business Owners, I encourage you to address the issue of your business and the real estate that it inhabits. Whether you are currently in a position to own or not, begin taking the proper steps today. You will be glad that you did!
Please follow Todd Burkhalter and Drive Planning for ideas like this and many others which will enhance your personal net worth and your business’ value.