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STRATEGIC TAX SERVICES

Non Tax Issues

Exchange Basics

Non Tax Issues

The key in any effective wealth creation strategy is to avoid the impact of taxes as much as possible. As is the case with IRA's, the monies deposited in the IRA are able to grow without an annual or periodic levy of income taxes until the funds are distributed at retirement.

  1. Use of IRA to invest in investment Real Estate to broaden the type and diversity of investments in an IRA.
  2. Self-directed IRA's need not engage in 1031 exchanges in order to defer taxes on the sale of real estate that is not otherwise subject to Unrelated Business Taxable Income (UBTI).
  3. Limited source of capital.
    1. Due to the UBTI, restrictions on the use of debt, self-directed IRA's must rely upon contributions and internally generated growth to provide capital for real estate investments.
    2. Individuals are subject to a series of restrictions on the amount that may be contributed annually to an IRA.
      1. If the investor is an active participant in a retirement plan maintained by their employer, their annual contribution is eliminated for single individuals earning in excess of $65,000 and married couples earning in excess of $109,000.
      2. Otherwise, if the individual is not otherwise covered under a plan, the individual may contribute up to $5,000 per year, and $6,000 if catch up contributions are available.
      3. If the contributions cannot be made to a self-directed on a tax deductible basis, then contributions should not be made to the IRA because the limitations contained within the IRA rules are too onerous without the tax deduction benefit. The money can be contributed to a Roth IRA instead and the buildup in earnings and growth will not be taxed on distribution.
    3. The limited access to capital is the main barrier to investing in real estate. While stocks and bonds can be purchased in sufficiently small units to permit diversification, real estate tends to be larger scale illiquid investment that requires large amounts of capital to acquire. Furthermore, in the investing world at large, most of your competitors will be investing with significant amounts of debt which permits a lower cost of capital and consequently lower rents.
  4. One of the traditional methods to make up for the lack of capital in the real estate business is sweat equity. However, the prohibited transaction rules limit the involvement of the IRA owners, beneficiaries or their relatives to be actively involved in the management, repair and operation of the property. Furthermore, when an owner of a self-directed IRA who renovates the property, provides services beyond investment management, the owner assigns the income resulting from his or her service to the IRA. Under assignment of income principals, the income could be taxable to the IRA owner, with possible reporting and withholding tax penalties or the income could be treated as an excess contribution, subject to penalty tax. Alternatively, the IRS could also view the services as a prohibited transaction (furnishing of services by a disqualified person) and therefore disqualify the entire IRA.
  5. While it may seem obvious, none of the income produced by the real estate investment may be received by the IRA owners, beneficiaries or their relatives prior to age of distribution. This may take some of the fun out of the investment when a 35 year old investor realizes that he cannot receive any income from his real estate investments for the next 30 odd years.
  6. The typical self-directed IRA investors tend to be middle age investors, with a decent amount of capital in their IRA, whom have tapped out all other sources of cash and want to continue to invest in real estate. These individuals tend to be short on the rules and tax consequences and long on imagination and desire to improve their lives.
 
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