Good and Bad News on Using a Roth IRA to Invest in Real Estate

One of the coolest things about using a Roth IRA for investing in multifamily commercial real estate is that you do not pay any taxes on any gains. This can be especially advantageous if your syndication investments are doubling in value every 5 to 8 years. On the contrary, using a regular self-directed IRA to invest in a syndication allows the investment to grow on a tax-deferred basis, but a Roth IRA can provide the potential for tax-free growth. The downside is that there are certain restrictions regarding taking proceeds (distributions) out of the Roth IRA. Using a Roth IRA for your real estate investments can be ideal, so let’s take a brief look, shall we?

Traditional Self-Directed IRA vs. Roth IRA

The biggest difference here is that the self-directed IRA (SDIRA) is made up of pre-tax dollars while the Roth IRA consists of after-tax dollars. When you are in your retirement years and take money out of your SDIRA, that money is then taxed. Compare this to the Roth IRA where money taken out in retirement years is not taxed. This is because you will have paid taxes on the initial dollars that were contributed to your Roth IRA.

Roth IRA Good News

  • No taxes.
  • Because of lack of taxes, you can roll more of your capital into a new investment.
  • Unlimited number of Roth IRA accounts.

Roth IRA Bad News

  • Limits on annual contributions.
  • Cannot claim depreciation on an IRA-owned investment beyond that investment (example: your earned income).

Advantages of a Roth IRA

No taxes – The biggest advantage to a Roth IRA is the possibility for tax-free growth. Investments held in a Roth IRA can grow tax-free, as long as you do not withdraw anything before you’re 59.5 years old.

Rental income is tax free. – If you pay for a syndication investment entirely with Roth IRA funds, you will be eligible for tax-free syndication distributions from the resulting rental income. In other words, all profits and proceeds are not taxed.

Disadvantages to a Roth IRA

Custodians – Not all Roth IRA custodians are able or willing to take on a customer who is trying to purchase real estate investments. Some Roth IRA custodians limit investments to mutual funds, stocks and ETFs. As this can be a very precise and delicate process, not every custodian who claims to be able to handle these transactions is actually worth working with. You must research, research, research.

Fees – Expect many custodians to charge extra fees for complex investment-related transactions, especially those who actually do work with real estate and syndication investors. It goes without saying that some of these fees could possibly cut into the value or proceeds of your investment.

Depreciation – Under normal circumstances, such as investing in syndications with funds that are not part of an IRA, you can expect to claim depreciation on your rental property investment as a way to defer taxes. However, if you’re holding an investment in a Roth IRA this just isn’t applicable since you do not even pay taxes on any gains from a Roth IRA. To take this one step further, you cannot use any of the depreciation to offset any taxes on investment gains made with your normal (non-IRA) funds.

Designated Roth Account

To further confuse you, I’m going to mention a Designated Roth Account which is a little different from a Roth IRA, and is offered by many employers. A designated Roth account is a separate account in a 401(k), 403(b) or governmental 457(b) plan that holds designated Roth contributions. Designated Roth contributions are elective deferrals that the participant elects to include in gross income. The plan must keep separate accounting records for all contributions, gains and losses in the designated Roth account.

Qualified distributions from a designated Roth account are excludable from gross income. Generally, a distribution qualifies for income exclusion when it occurs more than five years after the initial contribution to the account and when the participant is age 59½ or older or dies or becomes disabled.

Investment Strategy

When you are younger (under 59½), you can invest up to $6,000 per year (2021) after-tax dollars to a Roth IRA. You can invest $7,000 per year after you reach 59½. 30 years of contributing $6,000 and 10 years of contributing $7,000, will give you $250,000 to invest however you see fit. Theoretically, as you approach age 70, having invested wisely along the way, you might have over $1,000,000 in value in this one Roth IRA. And with a good rate of return, 8% for example, you could be able to earn $80,000 tax free per year. Not bad.

Take Away

Plan ahead. Use your after-tax dollars to fund a Roth IRA. Invest your Roth IRA funds into projects that make sense and offer investment growth, like investing in a multifamily real estate syndication. When it’s time to take distributions out of your Roth IRA when you’re in your 70s and beyond, enjoy the fact that you won’t have to pay taxes… And then do cartwheels on the beach.

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