If you’re a real estate investor who took a loss this year, it might be a good time to consider a Traditional to Roth IRA conversion.
The right time to make a conversion from a Traditional IRA to a Roth depends on several present and future factors that are unique to every individual investor's life. With a Roth IRA
, cash is contributed "post-tax", meaning the contribution is made with taxable earnings for that year. This cash then buys assets (stocks, real estate, gold, etc.) on a tax advantaged basis. Assets can be bought, sold, or traded within the IRA without and without affecting the IRA holder's personal taxes.
With a Traditional IRA
, cash is contributed "pre-tax", meaning the contribution is taken as a tax deduction from earned income for that tax year. This cash can then buys assets (stocks, real estate, gold, etc.) on a tax deferred basis. Like a Roth IRA, assets can be bought, sold, or traded within the IRA without incurring capital gains tax, and without affecting the IRA holder's personal taxes.
When you reach 59.5 years of age, you can begin to withdraw from a Traditional IRA without penalty. You then pay taxes on the amount withdrawn. Early distributions may be taken from a Traditional IRA without penalties for unusual circumstances like a first home purchase, or certain medical expenses.
A key incentive behind opening a Traditional IRA is the projection that you will be in a lower tax bracket when you retire, and that your initial contribution will have grown on a tax deferred basis. Most 401(k)s, 403(b)s, Thrift Savings plans, and 457s are within the same tax status as a Traditional IRA.
One strategy behind converting from a Traditional IRA to a Roth lies in the projection that your tax bracket may be the same or higher upon distribution than at the time of contribution. Because Roth contributions are taxed when they enter the account, it could be beneficial to open a Roth IRA account when your anticipated yearly income is going to be less, and therefore your tax bracket is lower.
If you made some less than successful real estate investments or suffered a rental loss this year, you may be able to turn your loss into a gain by paying lower taxes on your contributions, and eliminate speculation on your tax burden at the time of distribution. Roth IRAs are also popular with clients who anticipate a large return on their assets. If you think that fix and flip is going to rake in the big bucks down the road, you may choose to avoid paying taxes on the return by paying taxes on the initial contribution with a Roth IRA.
Another benefit of the Roth IRA is the account holder’s ability to withdraw the principal amounts (your contributions) at any time without penalty or tax liability. When you reach 59.5 years of age, you can begin to take a distribution from the account (investment earnings included) without penalty and without taxes, as long as the account has been open for 5 years. Unlike a Traditional IRA, there are no Required Minimum Distributions (RMD) with a Roth IRA.
Both Traditional IRAs and Roth IRAs offer a unique array of advantages and conditions. The account that will best represent you and your retirement goals is wholly dependent on several present and future factors exclusive to your life as an investor. However, converting funds into a Roth IRA can be a silver lining to a particularly down year for real estate investors. Learn more about investing in real estate with your self-directed IRA at New Direction IRA's real estate page
. And as always, happy investing!