Investing in real estate through a Self-Directed IRA has become popular among those who choose alternative assets for their retirement savings. And that is not surprising since there are so many choices within real estate to help investors grow their money: apartment buildings, multi-unit homes, condominiums, commercial property, land, and single-family homes are all available to give retirement savers control of their assets and diversity in their portfolios. But did you know you can also have these same opportunities within a Self-Directed Roth IRA and collect rental income tax-free?
This is just one of the benefits of the Self-Directed Roth IRA for real estate. Many others can provide advantages to both you and your beneficiaries. Here are some of them:
Contributions to Self-Directed Roth IRAs are made after you have paid the taxes, and the earnings on the contributions are also distributed tax-free if you meet two conditions:
- You have held the Roth for at least five years.
- You are 59 ½ years of age or older, you become disabled or die.
Once you meet these criteria, you will qualify for tax-free distributions that include rental income from the real estate and any gains in value when you decide to sell the property.
No required minimum distributions (RMD)
Traditional IRAs require that you begin taking your money out (and pay your taxes!) when you turn 70 ½. These withdrawals, called required minimum distributions or RMDs, do not apply to the Roth IRA, which is a huge advantage for those who own real estate. It’s not hard to imagine the liquidity problems that investors could face if they are invested in real estate and did not have enough cash to make their annual withdrawal.
This will not happen with a Self-Directed Roth IRA because there are no minimum withdrawals to make. You may leave your money invested in property and allow it to keep generating tax-free income as long as you choose.
You may continue to contribute
Contributions to a Traditional IRA are not allowed after you reach 70 ½, but you may contribute to your Roth IRA indefinitely. This is an advantage for those who continue to work after their “normal” retirement age. You can keep adding funds to your Roth account and purchasing more real estate.
If you also have a Traditional IRA, you may consider converting some or all of it to a Roth IRA. A Roth IRA conversion entails taking a distribution of your Traditional IRA and contributing the distributed amount to your Roth IRA. You will have to pay taxes on the transaction, but there are no 10% early distribution penalties for the conversion regardless of your age.
Some real estate investors are buying their future retirement home in their Self-Directed Roth IRA. They purchase the property at today’s price, and later they can distribute it tax-free and use it as their residence.
The Self-Directed Roth IRA also benefits your heirs
Taxes are always an essential factor when you are passing down your assets to your beneficiaries, but they have several options on how to receive tax-free distributions from the Roth IRA they inherit from you:
- If you have had a Roth IRA for at least five years, your heirs can take a lump-sum tax-free distribution. This option is the perfect strategy for passing on real estate to them.
- There is also a five-year-rules option, which allows your beneficiary to hold the assets in an inherited Roth account until the fifth anniversary of your death. At that point, all the assets must be distributed, or they will be subject to a 50% penalty.
- There is also a life-expectancy option in which your beneficiary may deplete the account by taking a small distribution each year. The distributions must start no later than December 31 of the year following your death, and the amounts are calculated using the beneficiary’s age and the life expectancy the IRS has set. If the real estate generates enough rental income to fund the annual distribution, the asset may never have to be sold and can continue to provide income for your beneficiary for a lifetime.
You may even consider having a separate Roth IRA for multiple beneficiaries. This strategy avoids having to divide up assets, which can get complicated with assets such as real estate.