I am retired with a several rentals and looking to minimize taxes. I was reading a tax saving idea regarding using the equity in a real estate rental instead of withdrawing Retirement Savings. From what I understood, I can refi the paid off rental, do a cash out, and use money that to live on. Since that money is not income, it would not be taxed. That would allow me to not withdraw the money from my IRA, thus saving tax on those withdrawals and letting that money grow. I estimate the refi money will last me 5 years, then I'll sell the property, as I was planning to sell at that time anyway. According to my calculations, the tax savings was well worth the effort and made up for the additional expenses. Am I missing something?
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
7y
It's a valid strategy. The interest on the cash out refi will likely not be deductible as you're using the proceeds for personal expenses.
"Am I missing something?"
Real estate doesn't always appreciate (e.g. 2004 through 2009). What if you can't sell in 5 years because you're underwater? Not trying to scare you, all angles need to be considered.
If it's a traditional IRA, you're going to have to start taking RMDs eventually...also your rental real estate depreciation probably gets that net taxable income close to zero? It might make sense to withdrawl a little bit from the IRA each year -- or do a Roth conversion for a small amount each year depending on your age.
All good questions for your CPA and financial planner. Don't let the tax tail wag the dog.
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
7y
It's a valid strategy. The interest on the cash out refi will likely not be deductible as you're using the proceeds for personal expenses.
"Am I missing something?"
Real estate doesn't always appreciate (e.g. 2004 through 2009). What if you can't sell in 5 years because you're underwater? Not trying to scare you, all angles need to be considered.
If it's a traditional IRA, you're going to have to start taking RMDs eventually...also your rental real estate depreciation probably gets that net taxable income close to zero? It might make sense to withdrawl a little bit from the IRA each year -- or do a Roth conversion for a small amount each year depending on your age.
All good questions for your CPA and financial planner. Don't let the tax tail wag the dog.
You can certainly do this. Here're couple of things that you have not considered.
1. Overall numbers. Let's say you get a $50,000 cash from refi instead of taking $50,000 out of your retirement.
The cost of taking this money out of retirement is the income tax on it (which should be relatively low in your retirement and possibly offset by rental losses - could even be zero) plus loss of earning on this money inside your retirement account (depends on your investments and on the market)
The cost of taking this money as a refi is the closing costs of refinance plus interest you will pay on this extra borrowing (which also restarts on the original loan when you refi it!).
It's impossible to say which one is better long-term without all the pieces.
2. Taxation. The cash-out money is not really tax-free in the way most people think it is. It is true that you will not owe taxes at the time of refi, but you will still pay full capital gain tax when you sell this property - even if you get almost no cash at closing. Effectively, you will be paying capital gain tax on this refi money eventually.
Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
7y
@Eamonn McElroy@Michael Plaks - "The interest on the cash out refi will likely not be deductible as you're using the proceeds for personal expenses." - really???
Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
7y
@John Wolf definitely something to run by a CPA or financial planner because there are a lot of moving parts here. You may find that the overall "cost" of the refi proceeds to be higher than the tax on a 401k withdrawal.
There will be refi closing costs plus capital gains taxes when you sell the property.
Plus, will the appreciation of the real estate be greater than the yield of your 401k?
Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
7y
@Michael Plaks - what if you used a HELOC to buy the rental or a refi on the primary residence to buy the rental and now the rental is paid off, but want to get cash out to pay the HELOC/mortgage on the residence instead?
""The interest on the cash out refi will likely not be deductible as you're using the proceeds for personal expenses." - really???"
Yes. 3 times. One for each of your question marks.
"what if you used a HELOC to buy the rental or a refi on the primary residence to buy the rental and now the rental is paid off, but want to get cash out to pay the HELOC/mortgage on the residence instead?"
Interest tracing rules apply. I'd advise anyone thinking about this to consult their CPA beforehand. The authoritative guidance is pretty clear and explicit.
Financial Advisor · Blaine, MN · Member since 2014 · 477 posts · 387 votes
7y
@John Wolf I would be very cautious about selling properties in retirement. You can end up paying a ton of unnecessary taxes if you go about this without a good long term plan. I'd recommend talking with a financial advisor that understands the tax implications of selling real estate and how it effects your overall tax situation including taxation of social security benefits. It is worth paying a few hundred or even a few thousand dollars to avoid tens of thousands of taxes in retirement.
@Michael Plaks - what if you used a HELOC to buy the rental or a refi on the primary residence to buy the rental and now the rental is paid off, but want to get cash out to pay the HELOC/mortgage on the residence instead?
Not sure what your scenario is. Is you used a HELOC to buy a rental and now the rental is paid off - it means that the HELOC is paid off.
If you have a paid-off rental, you then obtain a loan against it and use the proceeds to pay any personal debt (credit cards, mortgage on your house, car loan) - then the interest is personal and is not deductible against the rental. If you pay off your home mortgage with it, it could be considered a refi of your mortgage and be deductible as your personal itemized deduction on Schedule A. However, the terms of any loan against a rental are usually worse than a homestead mortgage, so you lose this game.
General rule: look at what the loan is used for, not what it is secured with.
Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
7y
@Michael Plaks - so here is the history: before we moved to Texas, we acquired a smaller property purchased with funds from a HELOC. We then sold our residence (at which time the HELOC was paid) and moved to TX, rehabbed that property while we figured out what's where, schools, commutes, neighborhoods, etc. and found our current residence. We decided to get a loan at maximum LTV for the residence instead of refinancing the rental, so we left the rental paid off and mortgage free.
Later we refinanced the residence and pulled out more money we used to acquire another rental. All was fine because the residence loan was at very good rate and the interest was deductible as a personal itemized deduction. But now we don't meet the itemized deductions and wonder if/how to move that interest back on the rental side.
On the first property, the HELOC interest was deductible against the investment property until it was paid off. After that, there is no more interest deduction against that property, no matter what you do. You can only deduct the interest on some future borrowing used for improvements to this property.
On your new residence, let's say you originally financed $100k and then did a cash-out refi for $125k. The interest on $100k out of $125k is personal. So 80% of the interest on your current mortgage belongs on Sch A and nowhere else. I realize it's no longer helping your taxes - but that's how the new law works. You cannot move it anywhere, sorry.
If the remaining $25k (20% of $125k) was used to buy a new rental, then 20% of the interest on your mortgage is deductible against the new rental.