All Forum Posts by: Eric Lee

@John Woodrich

No, I was thinking of buying a house + rental unit with after tax funds, and paying myself for the work to manage the rental.  

That would be a business (generating self-employment income), which could be used to fund a Solo 401k.  

No transactions have taken place, I am learning about the options at this point.  

@Account Closed

Thanks for the comment. I hadn't known about that. Fortunately (I guess) our Roth IRA will be fairly small, so I'll probably end up in a stock fund. This would be another reason to go that direction with the Roth IRA. If they ever do allow Roth IRA -> Roth 401k rollovers that would be nice, though.

Would there be any issue with investing in the same real estate partnership with both self-directed IRA and after-tax funds? Or both my self-directed IRA and my wife's self-directed IRA?

I had been thinking of doing that.

@Nathan Click

Thanks for the comment. Using the IRA to purchase properties would be further down the road for us, I am looking at more passive partnerships now.

>Paying yourself to manage part of your residence while technically possible practically may or may not work. You can only pay yourself so much for the property management work and would be converting passive income into income that would be subject to self-employment tax...

Dmitriy,

Thanks for the info, I had not thought about self-employment taxes.  

As a rough estimate, if there was a separate 2 bed/2 bath unit that might rent for $3k per month (we are in a high cost area).  So, if we paid ourselves 8% of the rent (similar to what we pay for out-of-state management now) it might be an additional SE tax cost of (3000*12*0.08*0.153) = $440?

I like the idea of a local rental, as we did this several years ago, so I'm confident we do it (I did most of the repairs, we were able to find good tenants, etc.).  But if it won't work, I'll have to keep thinking about other side businesses.  

@Dmitriy Fomichenko

Hello,

I have been reading up on self-directed IRA's and solo 401k's.

I feel like I am starting to understand some of the details now, and have a tentative plan. I'm looking for any feedback/issues with it. Hopefully this post isn't too long...

My situation:

* I am interested in investing in real-estate partnerships in my retirement accounts.

* To complicate things, I currently have a traditional IRA (which I have rolled over previous 401k's into). I also managed to include some after-tax contributions in this IRA in 2005/2006, so it has a small amount of after-tax contributions in it.

* My employer allows after-tax payroll contributions into my 401k, which can then be rolled over (in-service) into a Roth-401k (or an external Roth-IRA). This seems like a very good way to boost my Roth savings, as the contribution amount can be pretty large.

* If it doesn't complicate things too much, I would also like to make a yearly (after-tax) Traditional IRA contribution, and roll that into a Roth IRA.

* Right now my wife and I don't have self-employment income (since passive income from rentals and investments don't count). The rentals we have are not local, so we aren't managing them directly.

Here is my thinking:

Overall, the solo-401k plan looks better to me than a self-directed IRA, due to all the reasons mentioned in other threads (UDFI not an issue for any future real estate purchases, no custodian requirements, possibility of a loan, plus it allows me to make a Traditional IRA contribution yearly and roll it over to a Roth IRA, without having pre-tax IRA funds complicating things).

But, without self-employment income (yet), maybe a 2-step approach makes sense...

####

Short Term:

* Start a self-directed IRA, using my traditional IRA account. Is there any benefit to separate out the pre/after tax portions into two separate IRA accounts now? i.e. will that make it easier to roll over the pre-tax portion into a solo-401k later on?

* Make annual "after-tax" traditional IRA contributions (my IRA already has after-tax contributions, so I'm assuming it isn't any more complicated if I make more after-tax contributions now).

* Start doing after-tax payroll deductions into my employer's 401k, then roll them into a Roth 401k (in-plan). When a solo-401k account is setup, then do an in-service rollover into a solo-401k Roth sub-account (where they can then be invested in real-estate).

####

Longer Term:

* Work towards generating self-employment income.

One possibility is if we sell our current house, and buy a place where we can rent out part of the property (4-plex?). Then we should be able to pay ourselves for the property management work. We have been thinking of doing this anyways, and this might be another reason to do so.

* Then, start a Solo-401k plan.

Roll over (pre-tax) funds from my IRA. As I understand it, this will separate out my pre/after tax contributions, so the after-tax portion can be converted to a Roth IRA. I think this will require calculating the gains on the pre/after tax contributions separately, likely with a CPA's assistance, but I don't understand all the details of this yet.

Question: Is it common for a solo-401k plan to accept "in-kind" rollovers of real-estate partnerships, etc. from a self-directed IRA? I wouldn't want to have to liquidate these partnerships to do the rollover.

Thanks for any feedback...

Gary, Steven,

I think this is a great discussion. I found this very confusing also. When I was digging into this earlier, though, my understanding ended up being that "excess passive losses" are applied against income in this order:

* Income from the passive rental activity during the year (which would be taxed at ordinary income rates).

* Gain from the sale (offsetting fed tax of 18.8% (if have 15% long term cap gain rate (for married joint income of 72.5k to 450k) + 3.8% medicare on unearned income)).

* Then against income from all other passive activities.

* Finally against all other income (i.e. active income from a salary).

This was from "Every Landlord's Tax Deduction Guide", in the "Profits from Sale of Property" section. If there was something I missed, though, I would love to hear about it.

So it seemed to me that you DID end up paying 25% in depreciation recapture, to "save" 18.8% of capital gains (if you have a lot of capital gain, which you hopefully would). i.e. a "net federal tax" of 6.2% on the suspended passive losses in the year of sale.

For California state tax, I know the calculation is different, and I think depreciation recapture does not apply, but would have to check that again.

It seemed that there were a couple of options to reduce this,

* One was to elect the 40 year depreciation in the first year, to slow the rate passive losses accumulate.

* Another thought is that if rents rise over time (hopefully true) then the passive losses would be consumed partially that way also (ideal case).

* I think a 1031 exchange causes the "suspended passive losses" to roll forward into the new property, so the depreciation recapture does not occur, but am not certain.

In the end we personally still ended up wanting to mortgage our new purchases, under the idea that we could obtain several properties with the same amount of cash, and would have capital gains on several properties as well. Plus we don't think rates will ever be as low in the foreseeable future, so if we want to take out cash from the property now is the time.

Best Regards,

Eric

Bill and Steve,

Thanks for the comments!
Our goal isn't actually to generate tax losses, everything is cash flow positive.

But as we sell our first rental property (a condo we kept as a rental when we moved up to a house) I am interested in learning more of the ins and outs of taxes on rentals, wondering if there is anything we should do differently for other properties we are buying.

I do understand that "depreciation recapture" is calculated whether or not you actually take the depreciation, so definitely you should claim a depreciation expense.

But, I am puzzled about the depreciation term.
From what I had read in http://www.irs.gov/publications/p946/ch04.html
it sounded like there WAS an option to choose a 40 year depreciation schedule, but it had to be chosen in the first year the property was put into service.

"Electing ADS. Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class that you placed in service during the year. However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Once you make this election, you can never revoke it.

You make the election by completing line 20 in Part III of Form 4562. "

and

"Recovery Periods Under ADS

The recovery periods for most property generally are longer under ADS than they are under GDS. The following table shows some of the ADS recovery periods.
...
Residential rental property 40 years
"

Is there something that would prevent us from choosing 40 year depreciation on a new property, if we wanted to reduce the "passive loss carryover"?

Thanks!

Eric

Hello,

We are learning more of the in's and out's of depreciation, trying to decide how to handle depreciation on some properties.

Basically:
* Our AGI is past the point where we can deduct any passive loss carryover against regular income.
* We expect there to be passive losses (at least initially) due to depreciation expenses.

While you are renting out a property it is clear that having enough depreciation expense is good, so you are not paying tax on the cash flow (and the future 25% depreciation recapture is a lower rate than the income tax rate, i.e. spending 25% in the future to save 30+% now).
But, if/when we sell a property, it seems like any "passive loss carryover" gets applied to current expenses, then to capital gains on the sale (taxed at 15% + 3.8%), then to any regular income you have. So if there are high (hopefully) capital gains it seems like you are spending 25% (depreciation recapture) to save ~19% (capital gains).

So, in general, is it a good idea to try to minimize passive loss carryovers?
Or do people go for a 1031 if there is a large capital gain?
(i.e. it looks like you have the option to elect a 40 year depreciation instead of 27.5 years but only can choose that in the first year)

Thanks!
Eric