1031 exchange with an inherited IRA?

17 Replies

I have money in an inherited IRA account, that I am pulling out to purchase an investment property. Does this type of purchase meet the requirements of a 1031 exchange? This purchase will significantly raise my tax liability at the end of the year, as it will bring my income into the 33% plus tax bracket at least. I am just trying to figure out how to mitigate that major tax bill at the end of this year. Does anyone have any advice on this, or some other type of strategy to mitigate that? Thanks!

Patrick,

if you are taking a distribution from your inherited IRA - you will be taxed on the entire distribution amount. Taking money out of an IRA and using proceeds to buy an investment property would not meet the requirements of 1031 tax deferred exchange.

You can avoid paying taxes by setting up self-directed inherited IRA and then investing in real estate from your IRA. This would not be taxable event so no tax liability to you. Then you can continue to take small distributions from your self-directed inherited IRA and only pay taxes on the distribution amount.

Further, if you decide to sell that property and reinvest into another investment you don't have to do the 1031 exchange since you are doing so inside of a tax-sheltered vehicle (IRA).

@Patrick Gerrity

I would reinforce what Dmitriy has stated above. Taking a large distribution from an IRA - inherited or otherwise - creates a significant tax liability.

If the purpose of the property is purely investment, then it will be best to make that investment within the existing IRA umbrella.

An inherited IRA can be converted to self-directed format. This is simply a different business model of handling investments so as to expand your choices for the IRA beyond conventional financial products. The IRA will remain an inherited IRA and retain the same rules with respect to your required distributions over time.

There are several quality providers of such programs active here on BP.  Do some reading and make some phone calls.  You will learn a lot quite quickly.

@Patrick Gerrity

Definitely use the inherited Ira as advised by @Dmitriy Fomichenko and @Brian Eastman to buy the property because you most likely can take as much out as you want per year you are in control and are required to take some$$$ based on your age and account amount. 

I am planning to be in Scranton at the end of the month if you want to talk. PM if you need info sooner. 

So I looked into it further and my Inherited IRA is in fact a self directed IRA... what's my move now? Thanks for the replies guys, I really appreciate it!

@Patrick Gerrity

"Self-Directed" is a broad term.  Most stock brokerage houses - that only sell stocks, funds, etc. - will refer to an account as self-directed if you choose your own financial product investments rather than working with a financial advisor.

A truly self-directed IRA will be held by a specialty institution such as @Carl Fischer 's CamaPlan, Kingdom Trust, IRA Services Trust, etc.  Such institutions have a different business model, and allow an IRA to invest in anything the IRS rules allow for, not just publicly traded assets.

Interesting. It's with Schwab. You would think I should probably know what I have, lol. I need to be more invested, that is readily apparent.

@Brian Eastman - I am in a similar situation. Is it true that if using a self-directed IRA the earnings must return to that account and cannot be pulled until retirement (without tax penalty)?

I’m strongly considering grabbing a chunk and just paying the taxes now. My goal is to acquire more MF properties with it and fully replace my W2 income by 40 (8 years away). If I would elect to leave my career at that point, I couldn’t necessarily live on the funds if they’re still sitting in the inherited IRA account, right?

Thanks in advance for your insight!

Craig

@Craig Fitzsimmons

An IRA is an IRA, whether self-directed or otherwise. The rules surrounding distributions are the same whether an IRA is invested in the stock market or real estate.

With an inherited IRA, you are required to take a certain amount from the account each year. The calculation varies based on who you inherited from, their age at death, how you were named as a beneficiary and your age. Discuss this topic with your CPA.

You are allowed to take more than the minimum amount if you choose.

Any amount you take from the IRA will be taxable income.

- - - -   SO

Taking a large chunk out of an IRA at one time will throw that income as well as any other income you have for the year into a high tax bracket. As such, you will be reducing your potential investment capital by a large amount. The return on investment you can generate with the remaining balance will be taxable.

If you leave the money in an IRA and choose to invest in an asset such as real estate that produces consistent income (as opposed to speculative appreciation gains common in equities), then you will have the full value of the account to work with. All gains within the plan are not taxed, only what you take out. If you take out less than you earn in a year, you are sheltering the residual and able to compound the growth over time.

- - - -  SO

You can kill a goose and have a dinner.

 - or - 

You can keep the goose and have eggs for a very long time... and choose to cook the goose at any time in the future if that becomes beneficial.

@Patrick Gerrity

The beneficiary IRA distribution rules should also be considered here. Did you inherit the traditinal IRA from your spouse or from someone else?

If from your spouse, then you can treat the IRA as your own IRA and you will not be required to take RMDs until you reach age 70 1/2.

If from someone other than your spouse, then you will need to commence annual IRA distributions by December 31 of the year following the IRA owner's death, and the distributions will be based on your life expectancy which could affect your investment decisions.

@George Blower it was from my parents estate. I am in need of cash flow at this time due to my son going to college, which is why I am going to be taking large chunks out at once. I was just hoping there was a good way to mitigate the liability.

@Patrick Gerrity

I think you are better off to try to grow it. However, If it is for your son Check and see with an attorney if you decline to inherit it and let it it go to your son who I presume will be in a lower tax bracket. 

@Carl Fischer thanks, by grow it do you mean leave it in the stock market? Or invest in real estate? My current plan with the money taken out is to buy multi family 3's and 4's.

@Craig Fitzsimmons

I would leave it in the IRA because if you take it out you will be "forever" taxed. I would consider building your own Roth and work both accounts together and if you get to the point that you are replacing your W2 income you can live off the income it is easy to take the money out of the inherited IRA at your spend rate. there is also a way to take the money out of your Roth IRA prior to reaching 59.5 years old. It is called Substantially Equal Periodic Payments(72t distributions) the amount you can take out with out tax penalties can be calculated 3 different ways to suit your needs and meet your spend rate. There are several other ways you can get some of the money without penalties as well.

@Patrick Gerrity

I don't disagree with what the experts have said above. But one question I have --- did you parents have a traditional IRA or a Roth IRA? Big difference when it comes to distributions.

Also depending on the number of heirs that your parents have, what the IRA documents say, and your income level, you may be better off disclaiming the inherited IRA. You want to talk to your CPA/Lawyer if the option makes sense. If you have any siblings, it probably doesn't work although I'm not 100% sure.

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.

Should step on your brakes to a complete stop. 1031 can be on its way out very quickly retroactive.  Give a few weeks for lawmakers to figure out. 

Hello Patrick,

You can always transfer your Beneficiary IRA to a self-directed Beneficiary IRA. Once in a self-directed you can purchase an investment property inside your IRA and your IRA will collect deferred income.

Please let me know if you have any questions.

Megan Galane, CISP

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.