An Additional Step to Consider Before Investing in Real Estate in Your IRA

I recently shared two key steps to do before investing in real estate in your IRA.

Step #1: Understand the Special Tax Treatment Rules for IRAs
Only certain types of income receive special tax treatment.

Step #2: Understand the Type of Income Your Real Estate Will Generate
Real estate can generate many types of income - some types receive the special tax treatment and others don't.

These two steps help create a clearer picture of the tax consequences to your IRA.

But, of course, these aren't the only steps to consider.

Even if you get through the first two steps and determine your real estate income won't be taxed in your IRA, it doesn't necessarily mean real estate in your IRA is the best strategy to reduce your taxes.

While I'm focusing on the U.S. tax law here, the approach and concept can be applied to retirement plans in other countries as well.

If you participated in the Rich Dad Unfair Advantage event a few weeks ago, you may remember I said I don't like putting a tax shelter inside a tax shelter.

An IRA is a tax shelter. Tax on the income is either deferred (Traditional IRA) or eliminated (Roth IRA).

Rental real estate is an example of a type of real estate investment that can be a tax shelter on its own. Rental real estate often generates losses for tax purposes even when there is positive cash flow. This is because of the depreciation deduction that can be taken on the investment.

When properly executed, rental losses can be used to offset other income which effectively shelters that other income from income tax. This can result in significant tax savings.

If an IRA has rental losses, the IRA is generally not paying tax so there is no tax to shelter. If an individual has rental losses, there is an opportunity to shelter other income, including W-2 or business income, from income tax. This results in not paying tax on that other income and those tax savings mean cash in your pocket.

In the analysis I've done with clients and for myself, the tax results are better when a tax shelter (rental real estate) is not put inside another tax shelter (an IRA). The tax benefits that are lost outside of the IRA are too significant.

This is why it is so important to take this additional step and not just look at the tax benefits inside the IRA but also the tax benefits outside of the IRA.

Understanding the Rules Not only do you need to understand the tax consequences inside your IRA, but you also need to understand the tax rules outside of your IRA.

Are there more tax benefits available to you if you invest in rental real estate inside or outside of your IRA?

It is very important to note that I've been focusing on rental real estate. The same approach should be used with different types of real estate investments in that the tax benefits inside the IRA should be compared to the tax benefits outside of the IRA.

There are even more steps to consider before investing in real estate in your IRA. Look for more on this topic in the future.


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Understand the Special Tax Treatment Rules for IRAs and Understand the Type of Income Your Real Estate Will Generate.
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