| You've seen the advertisements and news articles. | | | | Unrelated Business Income Tax |
| IRA funds can be used to make real estate | | | | In certain special circumstances, an IRA needs to pay |
| investments. But before you jump on this bandwagon, | | | | income taxes on the profits it generates. These taxes, |
| make sure you understand some of the tax planning | | | | called unrelated business income taxes, essentially put |
| angles related to this opportunity. | | | | the IRA investor in the same position as a regular |
| Passive Loss Deductions | | | | taxable investor. |
| Almost always, an important component of your real | | | | For example, if you're developing and then flipping |
| estate profits comes from the tax savings associated | | | | properties inside your IRA, you may actually be an |
| with depreciation. These paper losses, referred to as | | | | active trade or business. And in this case, your real |
| passive losses by the Internal Revenue Code, can | | | | estate investment--even though it's inside an IRA--may |
| save both small and professional real estate investors | | | | be subject to income taxes. (Your IRA custodian is |
| thousands of dollars a year in income taxes. | | | | supposed to report your taxable income and tax |
| Unfortunately, passive losses from depreciation and | | | | liability, and then pay the taxes but many don't...) |
| related, similar tax deductions won't benefit real estate | | | | And here's another example of a situation where the |
| investors investing through IRAs. | | | | unrelated business income tax can trip you up. If you |
| Capital Gains Preferences | | | | borrow money to invest in real estate--the typical |
| If you sell an investment for a profit--whether a stock | | | | situation in any leveraged real estate investment--the |
| or real estate--you get a tax break because your | | | | profit you earn on the money you've borrowed is |
| profit gets taxed at a preferential capital gains tax rate. | | | | treated as unrelated business income. Accordingly, that |
| In the best case scenario under current tax law, for | | | | profit is subject to unrelated business income tax. |
| example, your capital gains get taxed at 15% rather | | | | Unrelated business income inside an IRA is taxed |
| than at 35%. | | | | according to trust taxation rules, which means that as |
| Unfortunately, by putting real estate inside of an IRA, | | | | soon as you've made much money at all, you're taxed |
| you lose this benefit. In effect, the appreciation you | | | | at the highest marginal tax rates. Ouch. |
| enjoy from your real estate investment gets taxed at | | | | Closing Caveats |
| your marginal income tax rate rather than at the | | | | Real estate is a great investment. And real estate |
| capital gains rate. (Fortunately, the tax gets paid when | | | | belongs in any investor's portfolio. But you need to think |
| you withdraw the money.) | | | | carefully about buying into the idea of using your IRA |
| Note: This "problem" also exists for other investments | | | | to make real estate investments. If you do decide to |
| that produce capital gains, such as stocks and mutual | | | | invest in real estate through your IRA, first consult with |
| funds that invest in stocks. | | | | your tax advisor. |