Double Taxation on ROTH IRA contributions for down payment

Member since 2020 · 12 posts · 2 votes

I have a solid ROTH IRA and I was interested in using some of the contributions as the down payment on a property. That money has already been taxed (as per the definition of a ROTH IRA). However, once that money gets tied up in the property as equity, when I sell that property down the line, will I pay taxes again on that money?

I was asking a realtor friend and he didn't have an answer.

Obviously I'm not looking for "official" tax advice but does anyone know the answer off hand?

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Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Chris Fore

It depends on how you utilize the Roth.

If you take the contributions as a tax-free distribution to yourself, which you can do, that is now personal money. If you then invest that personal money in a real estate deal, you will be taxed on the gains unless you deploy a strategy such as a 1031 exchange to push those taxes down the road.

If you transfer the Roth IRA to a self-directed Roth IRA, then the IRA can make the investment into the property. All gains from rents or future sale would be returned to the Roth IRA tax free. If you then wait to take qualified distributions from the Roth IRA, you will never pay taxes on that income.

Keep in mind, it is not you buying the property using Roth money. The Roth IRA is investing in the property instead of something else like mutual funds. All expenses are paid by the IRA and all income flows back to the IRA.

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Chris SeveneyBusiness Member
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
3y
@Chris Fore
You should not get taxed when you sell the property
@brian Eastman could also add more info to this
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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
3y
@Chris Fore
It depends on how you utilize the Roth.
If you take the contributions as a tax-free distribution to yourself, which you can do, that is now personal money. If you then invest that personal money in a real estate deal, you will be taxed on the gains unless you deploy a strategy such as a 1031 exchange to push those taxes down the road.
If you transfer the Roth IRA to a self-directed Roth IRA, then the IRA can make the investment into the property. All gains from rents or future sale would be returned to the Roth IRA tax free. If you then wait to take qualified distributions from the Roth IRA, you will never pay taxes on that income.
Keep in mind, it is not you buying the property using Roth money. The Roth IRA is investing in the property instead of something else like mutual funds. All expenses are paid by the IRA and all income flows back to the IRA.
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Chris Fore
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Member since 2020 · 12 posts · 2 votes
3y
@Brian Eastman That was amazing. Thank you! And thanks @Chris Seveney for throwing it his way.

Just to clarify, if I use the Self Directed IRA for the downpayment, can I still make the payments from my personal account for the remainder of the mortgage period or does it all have to come from the self directed IRA? You said "it is not you buying the property using Roth money. The Roth IRA is investing in the property instead..." so I was a little confused as to whether I could "comingle" my personal and retirement funds for the remainder of the mortgage payments on the home.

Thanks for giving me a lot to research on Self Directed IRA's. All new stuff to me.
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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
3y
@Chris Fore
An IRA is tax sheltered savings. That tax favored treatment comes with the caveat of keeping the IRA at arm's length. You cannot personally benefit or comingle IRA and personal funds. If you do so, you break the piggy bank, so to speak.
Everything the IRA does must be entirely separate from you, lineal family, and family owned businesses - all of which are considered disqualified parties to the IRA.
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Alex Olson
Real Estate Broker · Kansas City Metro · Member since 2015 · 2k+ posts · 1k+ votes
3y
@Chris Fore Using IRA as ownership in real estate looks amazing on paper. But, they are difficult to maintain, manage and do well with for small, active investors. A 1031 exchange into and out of using an IRA can be very cumbersome. There are also certain rules and regulations (touched on above) that make it difficult to complete a transaction and can become costly. Not saying never to do it, but when it comes to long term wealth building, it is not a great option in my opinion.
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
3y
@Alex Olson,

I don't know if you have personal experience owning rentals or simply sharing feedback you've heard based on someone else's not so good experience, but the bottom line is this: your statement above is subjective. I personally own real estate in my Roth for years so are hundreds of my clients. Both of my rentals are out of state, I have professional property managers handle everything and so far it was fairly easy (not difficult) to maintain. Your comment about 1031 exchanges is a mute point because IRA's are tax-deferred vehicles and gains from sale are not subject to capital gain taxes. You can simply sell property in your self-directed IRA and reinvest proceeds into another investment (doesn't have to be like kind by the way), whenever you find that next investment, no time restrictions.

For me, owning those rentals was extremely beneficial in my overall wealth building. And I spoke with countless others who's results were even greater.

I would agree with you however that owning rentals in your IRA is not for everyone, just like owning rentals personally is not for everyone.
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Alex Olson
Real Estate Broker · Kansas City Metro · Member since 2015 · 2k+ posts · 1k+ votes
3y
@Dmitriy Fomichenko Not sure the net worth of your investor base you are mentioning or the active investor status that you are looking at but typical investors that I work with don't have IRAs that are large enough to pay all cash for multifamily family properties in the $1mm to $10mm range and the difficulties of getting a loan through an IRA is not something that sellers in this market are willing to be be patient on. In addition, since these IRAs don't pay taxes you don't get phantom depreciation expenses, no mortgage interest deductions, and likely no loss deductions. And, you have to abide by much stricter accounting practices. You have to pay others to do the work for you and you can not self manage. As I allude to, this is my opinion and experience. For those that want to be active investors and be aggressive in this market and put funds in to Kansas City, it is not an option I can get behind. For others, I am sure it is great because as you had 100s and thousands of people have done it successfully. Just difficult, cumbersome, and can put any deal that is under contract at risk of losing. I don't see the benefit of deferring taxes on your gain with an IRA that has heavy requirements for maintenance and mortgages for active investors - especially with no tax year write off.
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
3y
@Alex Olson,

I appreciate you sharing these details, but this discussion is NOT about typical investors you are working with. This discussion is about @Chris Fore using his modest Roth IRA to potentially buy an investment property. While his profile may not fit the profile of an investor you are working with, it certainly fits the profile of a typical investor using self-directed IRA to buy some rentals.
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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
3y
@Alex Olson
The issue here is really one of perspective. Frankly, you are outlining your difficulties with an IRA from a point of view that does not really align with the intended purpose of an IRA, so it makes sense that you would not find a good fit. When you look at it differently, it very well can make sense.
You are asking, "Is an IRA a good funding source for deals?" For the type of deals you are seeing, and with active hands on investors, the answer is generally no. An IRA is not intended to be a source for an individual to use to build their personal real estate enterprise, and cannot be co-mingled with personal funds or used in any other way where there is a benefit being exchanged between the IRA and the account holder.
The better question about an IRA is really quite different: "What is the best way to protect and grow the tax-sheltered IRA or 401(k) that I have?" In that case, looking at placing a self-directed IRA into real estate - whether a rental or a syndication - or notes, or something else where you can be diversified away from the volatility of the stock market and have more control over the outcomes can be a great option.
In an IRA you don't care about not taking advantage of depreciation, because the gains are not taxed in the first place. The exception would be when leverage like mortgage financing is used. In that case, the leveraged fraction of the gains is taxable to the IRA, and the IRA can use depreciation and other normal deductions to offset that taxable income.
And you do not need to have a high 6-figure IRA to take advantage of these strategies. Most of the investors we work with are putting between $100K and $400K into a self-directed plan. They may or may not have more savings allocated elsewhere. The bottom line is that if you can put long term, tax-favored savings into a stable asset that performs consistently over time, you can really accumulate a nice retirement nest egg while also feeling less exposed to market risk.
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Alex Olson
Real Estate Broker · Kansas City Metro · Member since 2015 · 2k+ posts · 1k+ votes
3y
Quote from @Dmitriy Fomichenko:

@Alex Olson,

I appreciate you sharing these details, but this discussion is NOT about typical investors you are working with. This discussion is about @Chris Fore using his modest Roth IRA to potentially buy an investment property. While his profile may not fit the profile of an investor you are working with, it certainly fits the profile of a typical investor using self-directed IRA to buy some rentals.
I'm not against using an IRA to buy real estate. But, I am against using an IRA funds for a down payment for active investors which is what Chris indicated he wanted to do. In my experience with the deals that are available, this won't work. I don't recommend active investors using IRA funds for down payment, in part, because of the tax consequences with adding debt. If he is buying real estate using no debt and wants to be active, maybe, but still not the most common way I would recommend. This is my opinion and advice about the info I have. Happy to chat more about it!
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Jeffrey DixonPro Member
Irvine, CA · Member since 2014 · 94 posts · 44 votes
3y
You would not pay personal taxes on the sale of the property. However, when an IRA borrows money, there is a tax that your IRA would incur. It is Unrelated Debt Financed Income tax (UDFI). All IRAs are subject to this tax. You would need to file a 990t tax return on behalf of your IRA each year.
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Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
3y
The sales price, sales expenses and basis will determine what your gain is on the sale of the property.
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