Real Estate IRA Tax Rates

New Direction IRA writes: Question: When you receive an IRA distribution of cash that was made from the sale of real estate, it is taxed at ordinary income tax rates. Isn’t this rate much higher than the capital gains rate you would pay on the sale of real estate outside of the IRA?

Yes, but this is true for any IRA asset, not just real estate.  Even if your IRA invested in securities like stocks and mutual funds instead of real estate, distributions of any gains will be taxed ordinary income tax rates. Traditional IRAs give you a tax deduction for contributions and you pay taxes on distributions. Both are at ordinary income rates which are higher than capital gains rates.

If your goal is to minimize taxes at distribution you may wish to convert your existing Traditional IRA to a Roth IRA.  Distributions from Roth IRAs are generally tax-free.  Conversion may be done at any time; income tax at ordinary income tax rates will be due on the converted amount. Many investors feel the Roth IRA is a much better long term plan as the taxes are effectively prepaid on the money; both contributions and the income and profits may be withdrawn tax free if conditions are met.

Much of the appeal of real estate investing is the positive cash flow it can generate. For IRAs owning real estate, generating income can make it an attractive option even without the potential for appreciation. The tax your IRA may incur at the end of an investment is only one factor to consider. Investors have the ability to generate significant revenue from rent. Cap rates of 4 to 10% are not uncommon and, when compared to returns from other assets, can be very enticing for investors in today’s economy.

In many cases, income generated from real estate assets can cover any Required Minimum Distributions (RMDs) required to begin for Traditional IRAs at age 70 ½ .

Remember, the point of owning real estate or any asset in an IRA is to increase the total value of your IRA.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.