“I have an IRA invested in Real Estate. Now how do I take that real
estate to live in, when I’m retired?”
Hopefully, that rental property has served your retirement
plan well, not only appreciating in value over time, but also providing regular
monthly cash flows over a number of years.
But what if you’ve decided you really want to retire and
live in that house?
If the house was purchased by your Roth IRA, and you’ve held
the Roth IRA for 5 years and turned 59 ½, it’s yours to distribute to yourself,
with no tax or penalties.
But what are your options if your real estate assets were
held in a Traditional account?
Certainly, you can distribute the house once you’re 59 ½,
without paying any premature withdrawal penalties. But you’ll have to pay taxes
on the dollar amount (in this case, property value) of your withdrawal, as
though that amount was some cash added to your income in the year you take it.
Naturally, since we’re talking about thousands of dollars, this may be costly.
However, you have a few options:
1) You can distribute
your IRA’s holdings a little bit at a time.
For example, at age 59 ½, you could begin distributing 10%
of the property from your IRA each year. If you distributed 10% in year one of
such a program, this would result in the property being owned 90% by your IRA
and now 10% share is owned by you. You’ll need to arrange with the title
company so that the ownership share is properly reflected accordingly each
year. You’ll still be constrained from using the property personally until it
is entirely distributed from the IRA. This will allow you to spread the tax
burden from distributions over a 10-year period.
Keep in mind, this will change your monthly cash flows. You
will personally be entitled to a direct 10% of income and responsible for 10%
of expenses. These proportions would need to be honored since there are now two
investors: you and your IRA.
2) You could consider
converting a portion of your IRA (including that real estate asset) to a Roth
IRA.
Yes, you’ll pay income tax on the amount you convert, but
this may make sense for you, if you anticipate a number of years more of income
to sock away, and for your IRA’s value to grow, before reaching age 59 ½. The
point here is you may be paying some tax now on a smaller amount, instead of
paying tax on a potentially larger amount down the road at retirement.
You could also convert a fractional share from your IRA to a
Roth IRA each year so that at some point in the future your Roth IRA owns the
entire property. Then, if you’ve reached age 59 ½ with 5 years in that Roth IRA,
it’s available to withdraw free from penalty or tax.
3) You may elect to
begin distributing shares of your property before retirement age by using the
72T method.
The IRS grants the 72T method (substantially equal payments)
as an exception, which enables one to avoid the penalty for early IRA
withdrawals.
The 72T exception offers a choice of methods, which you can
use to tailor the timeline of your distributions. All are based on your life
expectancy (or, if you elect, on the joint life expectancy of you and your
beneficiary), and whichever method you choose must be continued for at least 5
years or until reaching age 59 1/2.
