Tax Free (or Tax Deferred) Real Estate?

Ever flipped a property?  Ever made money on the flip? Sounds like a great thing, right?  It is.  Until the tax man cometh. Flipping properties in less than a year – which is what most people do – can be quite a tax burden. Generally short-term capital gains from real estate which include both rental and flipping profits are taxed at the same rate as your ordinary income.  This means you may have to pay 25-40% of the profits depending on what your overall income level is.

You worked so hard finding, renovating, renting out and selling properties to make your money.

And the tax man just sits back, waits til you’re done, and then takes his cut.

But there is a way to reduce, defer and eliminate the tax man from your profits…

Using Your ‘Self-Directed’ IRA for Real Estate and ‘Other Stuff’

If you work a regular day-job, you have probably heard that IRA’s are just for stocks and mutual funds.  That is sure what the big Wall Street firms would like you to believe.  But there is a vehicle for investing in real estate and pretty much anything else using an IRA.  And the same IRA rules apply.  Just as with regular investments, you can have a Traditional IRA, and a Roth IRA. Here is the difference between the two:

  • Traditional IRA – You can make contributions before taxes are taken out of your income, thus reducing the amount of money eligible for taxes.  Those contributions can grow without having to pay taxes and are only taxed when you make withdrawals, such as after retirement
  • Roth IRA – The money you put in is after taxes, so it doesn’t reduce your taxable income on the front end.  But any money you make in a Roth IRA will never be taxed, even when you withdraw it.

So far so good.  But with normal IRA’s, you will only be allowed to invest in such things as stocks, bonds and mutual funds.  However, there are a few companies you can find online that let you invest in other investments, using something called a Self-Directed IRA (SDIRA).  You can invest in real estate, mortgages, precious metals or a host of other transactions with a SDIRA.  Here are some real estate (or similar to real estate) transactions you can’t invest in:

  • Borrowing money from the IRA.
  • Selling property to the IRA.
  • Receiving unreasonable compensation for managing assets for the IRA.
  • Using the IRA as security for a loan.
  • Buying property for personal use with the IRA.
  • Investment in collectibles or life insurance policies.

How to Set Up a SDIRA

There are not nearly as many companies that will create an SDIRA for you as there are for regular IRA’s.  However, you can find several companies online that will do it for you.  Expect them to charge higher fees for your accounts because you are not buying their investments.  But the returns can definitely make it worth the price to set one of these up.  I personally have several SDIRA’s that I use to buy notes on mobile homes.  But note buying will be the subject of another post.