Lender · Dallas, GA · Member since 2016 · 47 posts · 36 votes
Hey family,
I purchased a rental property in 2016 under my own name for $135,000. The home is now worth $225,000 and I plan to sell it in the next six months.
My plan is to use the profit to pay off the mortgage on my primary residence. I was advised that there are tax savings when selling a home that's owned by a self-directed IRA. Is it true that I can avoid or limit capital gains taxes? If so, how is this done? I have some money in a traditional 401(k) and My wife has a little bit of money in an old 401(k) from a company she no longer works for. We are thinking about rolling her funds into a self-directed IRA.  Is it too late to incur the tax savings since I bought the home in my name or is there a way that I can put the rental home into a self-directed IRA before I sell it? Any advice would be greatly appreciated. The rental home has a mortgage balance of $111,000 if that plays a role in your answer. I expect my capital gains taxes to be north of $30,000 from the sale but I'm not really sure how to calculate what it will end up being.
IRA is tax-deferred vehicle and there would be no capital gain tax on a sale of an investment property. If the property is financed in a self-directed IRA - there would be Unrelated Business Income Tax on the profit from leveraged portion of the property (truly self-directed Solo 401k plan would be exempt from taxes on leveraged real estate).
There is no possible way for you to transfer existing property you own personally into your IRA! Also you can't combine your IRA with your wife's - each of you will need a separate IRA.
Thanks Dmitriy. Lets say that I convert my wife's old 401k into a SDIRA and I use it to purchase a property in the future. When I sell the property and make a profit I understand I wont have to pay a capital gains tax but I may have to pay an unrelated business income tax. The rest of the profit would be distributed to me correct? Or does all of the profit have to go back into the Self Directed IRA. In other words I want to be able to use the profits now.
All profit from investments owned by the IRA belongs to the IRA. You can take distribution from your IRA at any time subject to taxes (and penalties for premature distribution).
Investor · Fort Myers FL · Member since 2018 · 10 posts · 4 votes
5y
Hello Ronald,
Unfortunately, for a property you own personally, you would not be able to put this into a self-directed IRA account to get the benefits. If you set up an SDIRA for your wife, you can use it to purchase a new investment property. Then you would be able to defer taxes on sales.
Separately, a 1031 exchange could be an option for you to defer the capital gains tax, by exchanging this property for another investment property. This wouldn't help much in paying off your primary home but would save you from paying the taxes now.
IRA is tax-deferred vehicle and there would be no capital gain tax on a sale of an investment property. If the property is financed in a self-directed IRA - there would be Unrelated Business Income Tax on the profit from leveraged portion of the property (truly self-directed Solo 401k plan would be exempt from taxes on leveraged real estate).
There is no possible way for you to transfer existing property you own personally into your IRA! Also you can't combine your IRA with your wife's - each of you will need a separate IRA.
You can't estimate the tax due, and neither can we, because it depends on a whole lot of factors. I'll give you an example below, but your numbers could be very different.
- a $135k house possibly had $20k worth of depreciation since 2016. This potentially brings a $5k depreciation recapture tax at 25% - $225k can have $20k in pre-sale and closing costs, resulting in a $205k payout (before mortgage payoff, but mortgage does not change the calculation) - from $135k to $205k is $70k of appreciation. Possible capital gain tax is 15% of it, or $10k in taxes - so, my example results in a $15k total tax
Remember that your numbers could be nothing close to $15k, however it's unlikely to reach your $30k guess, especially since you're here in Texas where there is no state-level income tax.
Selling a rental property to pay off your mortgage may not be a wise long-term move - if this is your main reason to sell it. I'd run your plan by an accountant or a financial planner or at least a financially smart buddy.
There're ways to postpone your tax, but it will lock up your cash that you plan to use for the mortgage payoff, so it may not work for you.
Self-directed retirements accounts will not help you for this property. They could be used for other real estate deals. Again, this warrants consulting professionals. Good luck.
Thanks Mike. You made me a think about an online calculator that I used in the past that helped me to get pretty close. I was able to add GA State Tax along with some of the items you mentioned before. Thanks for replying
Unfortunately, for a property you own personally, you would not be able to put this into a self-directed IRA account to get the benefits. If you set up an SDIRA for your wife, you can use it to purchase a new investment property. Then you would be able to defer taxes on sales.
Separately, a 1031 exchange could be an option for you to defer the capital gains tax, by exchanging this property for another investment property. This wouldn't help much in paying off your primary home but would save you from paying the taxes now.
Thanks Matt. We will probably convert my wife's 401k into a SDIRA so we can invest in the future. A 1031 exchange would be a good idea for deferring taxes. I am ready to pay of this mortgage. It has been a dream thus far and to now we have the opportunity to do it so I'm going for it. Thanks again
IRA is tax-deferred vehicle and there would be no capital gain tax on a sale of an investment property. If the property is financed in a self-directed IRA - there would be Unrelated Business Income Tax on the profit from leveraged portion of the property (truly self-directed Solo 401k plan would be exempt from taxes on leveraged real estate).
There is no possible way for you to transfer existing property you own personally into your IRA! Also you can't combine your IRA with your wife's - each of you will need a separate IRA.
Thanks Dmitriy. Lets say that I convert my wife's old 401k into a SDIRA and I use it to purchase a property in the future. When I sell the property and make a profit I understand I wont have to pay a capital gains tax but I may have to pay an unrelated business income tax. The rest of the profit would be distributed to me correct? Or does all of the profit have to go back into the Self Directed IRA. In other words I want to be able to use the profits now.
IRA is tax-deferred vehicle and there would be no capital gain tax on a sale of an investment property. If the property is financed in a self-directed IRA - there would be Unrelated Business Income Tax on the profit from leveraged portion of the property (truly self-directed Solo 401k plan would be exempt from taxes on leveraged real estate).
There is no possible way for you to transfer existing property you own personally into your IRA! Also you can't combine your IRA with your wife's - each of you will need a separate IRA.
Thanks Dmitriy. Lets say that I convert my wife's old 401k into a SDIRA and I use it to purchase a property in the future. When I sell the property and make a profit I understand I wont have to pay a capital gains tax but I may have to pay an unrelated business income tax. The rest of the profit would be distributed to me correct? Or does all of the profit have to go back into the Self Directed IRA. In other words I want to be able to use the profits now.
All profit from investments owned by the IRA belongs to the IRA. You can take distribution from your IRA at any time subject to taxes (and penalties for premature distribution).
Lender · Dallas, GA · Member since 2016 · 47 posts · 36 votes
5y
@Dmitriy Fomichenko
Thanks for clarifying that. So in a nutshell, you should always buy a house with an IRA so you can avoid capital gains taxes. And then you can take a distribution out from the IRA and pay income taxes and and an early penalty versus paying capital gains taxes correct? Dimitriy, would you have time for a quick call later on today? Or sometime soon. 
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
5y
Yes. If you buy the houses in an IRA you can turn 15% capital gains tax in to 20-30% regular tax. And you lose out on the depreciation expense, and you lose out on doing tax free 1031 exchanges, and don't get the stepped up basis when you die, and if you benefit at all personally (like using your oceanfront rental for a vacation or paying yourself to do any work on it.) then your entire IRA becomes taxable and you pay early withdrawal penalties. So you have all those things going for you compared to not using an IRA.
Don’t put a tax advantage investment inside a tax advantage account or over complicate the entire thing.
Lender · Dallas, GA · Member since 2016 · 47 posts · 36 votes
5y
@Bill Brandt
Wow. Thanks for clarifying Bill. It sounds like there's more cons then pros with a self-directed IRA. I wonder why bigger pockets and everybody pushes this product all the time if there are all those downsides.
@Bill Brandt Wow. Thanks for clarifying Bill. It sounds like there's more cons then pros with a self-directed IRA. I wonder why bigger pockets and everybody pushes this product all the time if there are all those downsides.
You missed the key part of Bill's excellent explanation: do not put an investment that is already tax-advantaged (rentals) into another tax-advantaged vehicle (SDIRA) as it often backfires. SDIRA are excellent for other, NOT rental, investments: private lending, notes, active businesses etc. They all come with their own complications and risks. No free lunch.
Lender · Dallas, GA · Member since 2016 · 47 posts · 36 votes
5y
@Bill Brandt
Thanks Bill. That makes a lot more sense the way you explained it. When I started researching using a self-directed IRA I realized that every time I wanted to make a decision I needed to consult a custodian and there were so many different ways that a transition could be considered "prohibited". The huge consequences that come along with it almost steals the benefit. I suppose there are some high-powered CPAs that can find loopholes to everything, but for a small chipmunk like me, I'd rather choose the easier route. LOL
Yes, there are rules to follow, and it is very important that you understand them. And there are many many ways to invest successfully without violating any rules. No, there are no loopholes, you must follow the rules.
Wow. Thanks for clarifying Bill. It sounds like there's more cons then pros with a self-directed IRA. I wonder why bigger pockets and everybody pushes this product all the time if there are all those downsides.
Ronald, you are trying to compare apples and oranges. There is a place to invest using your personal savings and there is a place to invest your IRA funds. And you should do both, independently of each other.
Perhaps this will help you:
Suppose you have $100K in your IRA. Would it be wise to take distribution, pay taxes and penalties, giving uncle Sam 40-50% and invest what's left in real estate in your personal name without restrictions? I think it would be unwise move! You can keep the entire balance in an IRA, convert it to SD IRA and invest in alternative assets. Which investment to select depends on number of different factors such as your investment experience, risk tolerance, time horizon, etc. The question you have to ask yourself is this: "Which investment will give you better return and lower risk compared to your only option right now with your current IRA, which is confined to the stock market?"
For some, the answer is rental property. If you can get 15-20% return on your money investing in rentals in your IRA - that is way better than than the return they are currently getting in their IRA investing in the market. Capital gains taxes and depreciation expense is irrelevant here. For me personally investing in real estate notes is preferred with my retirement funds. For others - investing in tax liens or multi-family syndications, etc. etc. You have to look at your particular situation and see what's best for you, then make a decision based on that.
Thanks for clarifying that. So in a nutshell, you should always buy a house with an IRA so you can avoid capital gains taxes. And then you can take a distribution out from the IRA and pay income taxes and and an early penalty versus paying capital gains taxes correct? Dimitriy, would you have time for a quick call later on today? Or sometime soon. 
If you buy in a self directed ROTH IRA you will never owe tax on a property that the SDIRA ROTH sells.
I am only using SDIRA ROTH accounts for my properties that I want in a retirement account. I'd rather pay the smaller tax on the front end when the money goes into the account than pay tax on withdraws in retirement on the substantial gains and rental income the ROTH has collected.