Is there a way to defer some rental income into some kind of retirement account when retired?
Lets say someone was able to live entirely off savings for a year, could they somehow put their rental income into a deferred (not annuity) retirement account and pay no taxes?
The simplest thing is just to use the income from your rentals to fund your contribution to your IRA. Unfortunately, that's only a few grand per year and is subject to income limitations.
You might look into a Solo 401K and see if you could set up a company that owns rentals and using the income to fund the 401K. The contribution limits are much higher. You do need to watch out for the self-dealing rules. Those probably mean you can't put current rentals into this deal. You already own those, so selling them to a qualified plan of any sort isn't allowed. Solo 401k's don't work for me because I have a regular job, so I've not looked at them in detail.
I know very little about this stuff (so hopefully someone smarter will come behind me) but I do remember my financial advisor telling me something about being able to do this using some kind of "universal whole life" product. PM me if you want his info to talk to him!
The simplest thing is just to use the income from your rentals to fund your contribution to your IRA. Unfortunately, that's only a few grand per year and is subject to income limitations.
You might look into a Solo 401K and see if you could set up a company that owns rentals and using the income to fund the 401K. The contribution limits are much higher. You do need to watch out for the self-dealing rules. Those probably mean you can't put current rentals into this deal. You already own those, so selling them to a qualified plan of any sort isn't allowed. Solo 401k's don't work for me because I have a regular job, so I've not looked at them in detail.
Jeff S.,
Jon is correct. your best bet would be to consider operating a company that handles the rentals. This is one of the reasons some choose treatment of their rental income on Schedule C after opening a (single member LLC) or a corporation (S or C). Depending upon how great their income is they can choose to open a retirement plan, You can have a Solo 401k, You can also have what is called a defined benefit plan can allow funding into a pension up to $200,000. This can eliminate the need for paying a salary or a paying Self Employment tax by bringing earnings down to zero.
Here is an article to read from CNN Money.
http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index.htm?iid=EL
Here is an older article on the topic: http://www.smartmoney.com/taxes/income/the-perks-of-the-solo-defined-benefit-plan-18048/
Jon Holdman, there is nothing in the tax code preventing you from having a 401k from more than one company. You just cannot exceed the contribution limits.
-Steven the Tax Guy
-Steven the Tax Guy
I assume you mean the limit is a total for all contributions, $17,000 for 2012. So, if I have my day job and contribute money there, and have a C-corp company that owns my rentals and pays me a salary from the rental income, then I could contribute to that company's 401k, too. As long as the total was less than $17K (plus catchup, which, unfortunately, does apply to me.)
Don't these Solo 401k plans have much higher limits, like $45K or some such? How does that come into play?
Honestly, I'm not sure I even want to do something like this. I have a large percentage of my assets in qualified plans, and a much lower percentage outside qualified plans. I'm guessing tax rates will be higher in the future, and those qualified plan monies are going to get taxed later.
Jon Holdman,
assume you mean the limit is a total for all contributions, $17,000 for 2012. So, if I have my day job and contribute money there, and have a C-corp company that owns my rentals and pays me a salary from the rental income, then I could contribute to that company's 401k, too. As long as the total was less than $17K (plus catchup, which, unfortunately, does apply to me.)
Yes, that is correct.
Don't these Solo 401k plans have much higher limits, like $45K or some such? How does that come into play?
The solo 401k plan has the same contribution limits, they just allow for profit sharing contributions of up to 25% of your salary.
Jon, You might want to consider rolling over the amounts contributed to a ROTH account each year. Yes, you will pay tax on it now; however, it will be exempt from taxation later on. After 5 years you can pull out the principal anyway. That means you can invest it in real estate and not worry about having to tap into it at a later time.
I have clients who contribute to the maximums and now roll over each year the amounts in full. This allows them to pay tax now and have greater contributions to the ROTH accounts.
-Steven the Tax Guy
Jon Holdman"I'm guessing tax rates will be higher in the future, and those qualified plan monies are going to get taxed later."
I know. Can pull money out and pay tax at today's rate, then if possible put back in later. Problem is earned W2 this year raising income this year over next year.
Steven Hamilton II "Jon is correct. your best bet would be to consider operating a company that handles the rentals." Are you saying Steve this could be done with exiting rentals?
Jeff S.,
This is quite possible and is very true if you contribute them to a Family partnership or other investment vehicle.
Sometimes the best way to hold things is through the family business. The family operating agreement can state who is allocated any income from certain ventures.
-Steven the Tax Guy
Not sure how much income you are actually receiving once you factor in any expenses that you get to offest the income such as (taxes, insurance, repairs, mortgage interest, and depreciation) Maybe you paid cash for these and have great cash flow with no mortgage interest deduction. As many have mentioned you could open an IRA and simply make a contribution to the IRA that would offset some of the income. There are some ways that you can use life insurance and get some benefits for deferred taxes and they will talk to you about how you can borrow against the life insurance when you need the money and essentially never pay taxes and then you will have a death benefit that pays off the loan when you die and leave your beneficiary with whatever is left and never having paid taxes. Problem with most real estate investors is that if you are buying properties that are producing such great returns for you to produce this income that you are wanting to defer taxes on you also need to consider the investment options you will have in that life insurance vehicle or any other vehicle. I certainly wouldn't want my money deferred into an account that it going to average low single digits if I had the abilty to buy great cash flowing rentals producing well in excess of that.
Also it sounds as if you are no longer employed in w-2 position so what is your taxable income and your marginal tax bracket: Are you in a high tax bracket where it makes sense to defer all this income?
I see people doing everything to avoid paying taxes and at times they are not in a real high marginal tax bracket to begin with.
Tim Delp,
One big problem is not many people are comfortable with insurance products. They don't fee very secure in something they can't see and feel. Also they only pay a death benefit if they are funded enough. Plus why would I want to put any of my money anywhere else if it is not earning double digit returns. I nearly guarantee a return based upon my purchases. Why should I even risk my money in someone's insurance fund.
-Steven the Tax Guy
I like the idea of dictating what my income is and how much of it is taxable. Just looking at options. At this point probably would only pay self a management fee on the rental income and defer the rest in whatever way makes the most sense.
Won't do anything this year as this is probably the lowest tax brackets we are likely to see for some time. In fact may sell some things and take the gain with favorable cap gains tax.
Jeff S., Don't hesitate to ask any questions.
-Steven the Tax Guy
@ Steven Hamilton:
Not sure if you read my entire post as I'm not an advocate for cash value or whole life insurance. As I mentioned in my post if you are making good returns, let's say in excess of single digits on cash purchase I think an investor needs to fully think about the tax advanatages of deferring income taxes in a life insurance policy that is going to limit their investment options and their returns.
As I mentioned what makes sense for this individual posting the questions depends upon their personal preference first and foremost and then from a numbers perspective it would be good to understand exactly how much income are they talking about from this property, what is their marginal tax bracket and what are the investment options they are considering for this cash flow they are receiving.
I am 6 mo into retirement and expect to get something going after a year retired. I don't know what I will make but am looking at the pros and cons of sheltering some income.
Nobody knows what the future holds but with the possibility of all of us losing some ability to shelter income the discussion now is purely academic.
If a corporation is set up then we are looking at the possibility of double taxation.
I have about 20% of my net worth in deferred accounts so not feeling like there is too much there.
I don't know what my brackets will be having 3 months of W2 this year and don't know what my income will be next year when (and if) I get something going.
All I know is I want to enjoy myself and am not going to stress working lots of hours anymore.
I am keeping track of my spending and fine tuning what I need.
If I figure I only need 3k a month to live then only paying taxes on that may make sense but may not be worth the hassle to set up anything elaborate.
Putting money away for retirement is 2nd nature to me and even though I am technically retired part of me still wants to defer some income. It is mostly a habit I guess.
Tim Delp,
I did read it. I was just pointing out why some people are so opposed to it.
Jeff S.,
If you need help figuring out what bracket you'll be looking at I'd be happy to post some assistance here on that topic.
Don't forget... an S-corporation does not have double taxation. (there could a small percentage at the state level. But that is where we lower income by having deductions to retirement plans.
Also, I wanted to mention that since this will be a low income year. You might want to consider rolling over some of your retirement accounts into ROTH accounts so you can pay a lower tax rate this year and be able to use the principal after 5 years or when you turn 59.5 whichever is earlier.
-Steven the Tax Guy
I know you are just looking at this from an academic stand point but wanted to throw another consideration as you are looking at trying to get 'passive rental' rental income in to a deferred tax vehicle. Passive rental income does not require you to pay social security tax since it is not earned income/wages. In order to put money in to a retirement account it must be earned income. If you convert your properties to a more sophisticated s corp or something and claim it as earned income you are now self employed and would have to pay social security tax on that income of close to 15% all to then get the income in to a tax deferred account. I'm sure there are some ways you might avoid some of this but I would imagine whatever amount you are wanting to get in to the tax deferred account at a minimum that amount would need to be considered earned income and thus you pay social security on that amount.
There might be times where this is beneficial if you are in a very very high tax bracket but it sounds like you have or are about to have no earned income and not sure about what you will be receiving in retirement in terms of pension, ssi, withdrawals from taxable ira etc but it sounds as though you might be in a low tax bracket to begin with and not worth any of the hassle to do anything complicated like setting up s corps etc.
Do you just own the 1 property, what is the estimated annual positive cash flow after depreciation, taxes and insurance and other expenses?
Thanks Steven Hamilton II I can easily enough figure out what my bracket will be for 2012. I suspect it will be 28% after all is said and done. Considering taxes will almost certainly go up I don't need to defer any more income this year and will capitalize on the 15% cap gains rate too. Just got a note from Fidelity suggesting harvesting losses this year. Think I'll wait for higher cap gains rates to do that.
I am 59.5 but don't want to take money from deferred comp. Considering I did work this year and may not earn anything next year, it may be beneficial to wait anyway. I understand the argument about paying taxes on some deferred compensation and converting it to a roth. Might do this in the future. While the overall rate might be higher, mine may be lower.
Tim Delp it is not really appropriate to get into financial details online. Suffice it to say some people take cruises (can we say Rich Weese) in retirement and some people clip coupons. I like clipping coupons as along as I don't have to pretend I like bosses who have a say about whether I take home a pay check.
You bring up an interesting point about paying SS. I do expect to pay SS on business dealings but hadn't considered that putting rental income into a salary via a corporate entity would trigger that.
I plan to let the chips fall as they may this year and spend time with my accountant and whoever else that may be beneficial next year. Maybe a call now might be a good idea.
Interesting discussion.
Jeff S- I like other things besides just cruises! tic. I'm currently at our little park model in AZ on a golf course. I golf 6 mornings a week at 6:30 am, then work out in the gym. Nice jacuzzi and then some pickleball in the afternoon and Texas Hold-Em in the evening. We've had this type discussion before and LOTS of depreciation helps.
I remember chatting before your "retirement" and then it came sooner than expected. Hope all is going well for you. Rich
Most of the replies to the OP's question don't make sense to me. Rental income is passive income. Only active (earned) income can be contributed to a retirement account.
Why anyone would want to create an active income business to manage their own properties just to have active income that becomes subject to payroll taxes in addition to the ordinary income tax is beyond me. Converting passive income to active income and higher taxes just to have the ability to contribute to an IRA does not compute for me.
The suggestion to contribute to a Roth muddies the issue even more. Contributions to a Roth are made with after tax income, so converting passive income to active income just to pay higher taxes on income that can be contributed to a Roth IRA makes no sense at all.
The original poster's objective was to lower the tax bite on his current rental income. All of the suggestions posted make perfect sense if the OP was asking about active income, but make no sense to me when the income he is asking about is passive to begin with. Also, please note that the OP is planning to start a rental activity in retirement, so his future income is not likely to be taxed in a lower tax bracket in the future when he withdraws his funds from the IRA.
I realize that I am just a tax nerd and not a CPA, so maybe someone with more formal tax training can explain why converting passive income to active income (that is subject to self-employment income taxes) makes sense in the context of the OP's original question.
Look into a Self Directed Roth IRA. You can only contribute funds to it on which you have already paid taxes, and when you withdraw those funds (at age 59.5+) you pay no taxes on them. You can set it up so a self-directed Roth IRA can buy an investment property, and all revenues from the property flow directly into it--and are never taxed as long as you don't withdraw those funds for 5 years. I just did this with a self-directed account at MidAtlantic IRA, which is in Maryland, where I'm investing. I wanted an IRA custodian in the same time zone.
Nancy Roth,
Thank you for your response, but it does not address my question. I believe there are a few issues with your strategy for the original poster as well.
First, funds used to purchase the rental property must already be in the SDIRA so the IRA can buy the property. As I understand the rules, using a bank loan outside the IRA to fund the acquisition brings unrelated business debt issues into play with adverse tax consequences. Since the original poster is planning to start investing in retirement, I am assuming that he is planning to fund his IRA from his rental income activity and not from a Traditiional IRA rollover.
Second, I believe the five year rule you cite on withdrawals only applies to Traditional IRA to Roth conversion funds, not to funds that were contributed directly from earned income. Again, the funds contributed to the SDIRA have to come from earned income, not from passive income.
Since the OP is limited to funding his IRA from passive income sources, and passive income can not be used to fund an IRA, I still question the advisability of converting passive income to active income and paying higher taxes on that income just to be able to contribute after tax dollars to a Roth IRA.
Rich Weese that sounds like an ideal life. I am hitting the course too but only when it isn't pouring rain which it will be doing for a while.
I hear people talk about Park Models but not sure what that is. I gather it is a trailer of some sort. Anything on a golf course couldn't be bad in my book. Have never thought along those lines. What might one pay in total expenses per year to own one and what kind of upfront costs would there be. I remember you talking about it some time ago but it wasn't very relevant to me at the time.
Nancy Roth when I ask some financial people about SDIRAs for RE they say that in losing your depreciation write-off you lose a primary benefit of RE ownership. It seems complicated and wonder if other avenues might be wise to pursue first.
Dave T thanks for the thoughtful responses. Was thinking someone a little higher up tax knowledge wise would pipe in. So, what if I took one rental and assuming I won't need any income from it for as long as I can think of, contributed it to a family business (as Steven Hamilton II) suggests and poured all its income into a pension expense, would that not be a good idea? Are you saying that when I pull money from the pension I would have to pay SS? I guess the question then becomes,why would anyone do it? My guess is someones income is so high and their tax bracket so high that the tax benefit would override the need to pay SS?
Was talking to a guy (business head) and he acted like I was kind of nuts for even wanting to contribute to retirement since I was old enough to withdraw it. This is a different kind of thought pattern for me. Maybe he is on to something.
What does anyone think? Does it make sense to bag the retirement account idea when 59.5?
Jeff- A park model comes in on wheels/axles and then is anchored down to footings etc. You can add to it (called Arizona rooms here in AZ) I have a separate office/craft room with laundry facilities. Our entire lot is patio and covered with awning. 2 car parking plus my 32 Roadster golf cart. We're located in Palm Creek Golf and RV Resort. Multiple pools, super 18 hole exec golf course (tough) jacuzzi, weight room, lawn bowling Professional softball field with all the amenities, 24 professional pickleball courts, tennis, lapidiary, wood shop etc, etc etc. Over 50 different clubs and great people from all over. Our park has 2000 residences and const going on for another couple hundred.
The home is basically 1br-1ba with kit, lr and dr. You sleep inside and then go play all day. We have MANY oregonians here and about 50% canadians as well as folks from all over the country. Most are only here 6 months or less. To view the fun
palmcreekgolf.com . We love it . Many people want to escape the rain/cold/snow and go to AZ, TX, and FL. Rich