Should I cash out my IRA to buy investment property?
I have two retirement accounts, one that is my main account that I'm contributing to and on track for retirement, but I also have another IRA from a previous employer worth about $330,000. I'd like to cash that out and buy some investment property, but I'm not sure about taxes and penalties. I don't want a huge tax bill at the end of the year. I'm currently in the 28 percent tax bracket, with an AGI of $250,000. What should I do to minimize losing money?
The easy answer is don't do it. But I don't think that is a fair answer. Finding the right answer will take a lot of equity - sweat and cash equity (and possibly debt) to determine the answer to that.
In fairness to investing in securities, real estate, or whatever, the real answer lies in doing value analysis i.e. net present value analysis and IRR to start. You will need to compare the value proposition of leaving your money in your IRA vs the value proposition of taking it out and investing in real estate. That analysis will have to include after-tax cash flows which makes it a bit harder.
I would add one more thing. If you are chomping at the bit to try this and will do this regardless of advice provided please take this into consideration - do NOT overextend yourself. Let's say you want to invest in a multifamily house to rent out, you can purchase ONE property. Using debt (mortgage) and equity at a ratio of 75%/25% will greatly reduce the cash equity out of your IRA (assuming you don't live in major metro area with crazy property values). And if the investment property isn't meeting your return expectations then at least you didn't sacrifice your entire IRA. If you find that it is and you enjoy it, then you may want to consider more investment properties.
I have worked with many clients who own investment properties, and some are more successful than the others. Unless you can fully devote your time, energy, and finance into the investment properties, there’s a chance you will not get a higher return. Most people only look at the rental income generated, but forget other financial factors (tax, no rental income when renters move out, repair costs, management fees, HOA fees, attorney and court fees, etc.) and non-financial matters (fixing a leaking toilet, periodical maintenance, etc.).
If you truly want to get involved into managing the investment property, try to find other ways to finance the deal. Cash out all or a portion of the IRA is not the best way as tax alone will cost you more. Especially if you’re under 59 ½, add another 10% early withdrawal penalty on top of what your current tax bracket is when you file the tax return next April, 15.
Lastly, by IRS definition, all rental activity is passive. Unless you’re actively involved, you’re limited to the $25k tax loss from the rental activity. The $25k loss is further reduced by 50% of your MAGI (AGI without regard to passive activity loss, SS benefits, and qualified retirement contributions, etc.) exceeds $100k income. Any excess rental passive loss is suspended and treated as other passive activity losses carried over.
Thus, in order to succeed your new adventure and achieve better investment return, you need to first learn the rules of the game. Talk to a real estate professional and consult with your CPA and financial planner (CFP®) would be a good start. Best!
You'll be faced with a large tax bill if you choose to use your retirement account to fund an investment property purchase. You'll have to realize the withdrawals as income, thereby increasing your tax bracket for the year. Plus you'll pay a 10% penalty on top of it all!
I'm curious as to why you would want to invest in an investment property as opposed to managing the funds in your IRA. Compared to the time and energy it may take to manage an investment property and the historical returns comparison (depending on your allocation in your IRA), I'd argue when investing for retirement it'd be best to leave in your IRA.
Even if you believed you could earn a better ROR on your investment property than your IRA, the taxes alone should deter your from funding it by withdrawing funds from your IRA.
Best of luck,
No need to cash it out if your work with a custodian that can support a hard asset investment.
That said, real estate is tricky in IRA accounts, as DIY projects are a no-no as the value of your work is considered a contribution to a retirement account. Also, gotta make sure you have money set aside in the account for taxes, maintenance, etc., etc., as an outside payment for the benefit of IRA held real estate, would also be considered a contribution. Additionally, there are rules against personal use of an IRA held property.
Handled correctly, all is good, but do your homework before proceeding.
If the restrictions mentioned above are too high, and you are compelled to pull money out of an IRA (paying the 10% penalty and 28% income tax, and essentially getting 60 cents on a dollar our of the IRA), to "do your own thing", consider keeping the money in the IRA and buying one of the many thousands of Real Estate Investment Trusts (REITS) that invest in real estate and pay decent dividends to holders. I've seen good quality REITs that own lots of different individual properties, generating between 5-7% in annual dividends, without the stock holders needed to lift a screwdriver. At 60 cents on a dollar distribution, if you invested in a REIT inside your IRA and picked up a 5% dividend, you would need to find a real estate investment outisde the IRA that would generate about 8.5% net cash flow. And even if you could make up for the cash flow differential, you would still have to recon with an investment worth 40% less than it would have been inside the IRA due to the money you willingly paid IRS when you took the distribution.
By simply comparing the net cash flow you can generate yourself to what is available in the open market, you can save yourself from getting invovled in terrible single property deals.
Hope this helps,
Easy answer. NO, DO NOT DO IT!
With the probable 10% early withdrawal penalty and the resulting higher fed tax rate will mean you may well get less than 50% of the account value after tax and penalties depending on State and Local income tax.
What you could do is invest in publicly traded REITs for an exposure to investment real estate but within your retirement account so there are no taxes or penalties.