RMD Tax Bomb Cometh

[Wymo56]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

[TomatoTomahto]

Imo, the important thing is to reframe it; it’s not a tax torpedo, it’s deferred taxes becoming due.

Charity and Roth conversions are the usual go-to fixes, but it should probably read “fixes.”

We were once worried about RMDs; in the intervening years, our good fortune made us realize QCDs can be a good way to give.

[toddthebod]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

Can you take out a mortgage on the property within the IRA to get the cash for RMDs and accompanying taxes?

[retiredjg]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

Welcome to the forum.

We have many threads on Roth conversions before RMDs, but I don't recall any that involved a self directed IRA containing rental property.

Is this $1.2 million in rental property your only tax-deferred account? Or just part of your tax-deferred assets? The reason I ask is that $1.2 million is not enough to create much of a tax bomb and "accelerated Roth conversion" would be an over-reaction. You may not need Roth conversions at all if that is all you have tax-deferred.

If you have other tax-deferred assets, I think you could take your RMD and the tax from those rather than sell rental property (at least early on).

I hope you didn't pay $9,300 to get just an opinion. Is that a fee to help you convert?

There are no tax-avoidance products to help avoid RMDs...that I know of (other than QCDs which you are not old enough for). I suppose you could kick the bucket, but suspect that is not what you have in mind.

Do you want to sell or hold onto these properties?

The only way we can even start to help is to have a clear picture of your tax situation and your current assets. See the format in the link at the bottom of this message for how to present that information. For this question, we do not need to know what investments you have in each account. We do need the header information (age, tax bracket, etc.) and the size of each account (for both of you if you are married.)

[shess]

Their fee is $9300!

I'll be honest, I just spent a half hour reading, and to me the take-home point is that putting real-estate in a self-directed IRA creates a nightmare for distributions. Since RMDs have the value of all tIRA accounts as an input, you'll need a FMV every year to calculate the RMD. If there is not enough liquid in the account to cover the RMD, you can take an in-kind distribution of the property. Once you've done that, you need to make sure things like property taxes are allocated appropriately across the fractional owners, so the IRA pays its part and the individual pays their part. I doubt any charity would be willing to take an in-kind transfer without selling it.

That said ... if you have rental properties in the account, not a single LLC, I could see some argument for staged conversions into Roth, because once in the Roth you don't have RMDs. It sounds like you can do partial transfers, which obviously makes things more complicated, but if the properties are modest enough that you can do the conversion in two or three years, it might be reasonable.

As someone else mentioned, you could perhaps do something with a mortgage to ease this. I suspect it would look like transferring enough into the Roth to make a down payment suitable for the mortgage, then have the Roth purchase the property, leaving the tIRA more liquid, then you spend a couple years converting the liquid funds to the Roth and using them to pay down the mortgage. Or vice versa (mortgage in the tIRA to fund liquid assets to convert until the Roth can buy the property).

Maybe I should contact my relatives and make sure they don't have any rental properties in IRAs, because I can't think of anything about this that would be improved by having it in an inherited IRA.

[sc9182]

if a/such rental property held outside of IRA., chances are that., accumulated depreciation could be ZEROED out upon death - and inheritors could thus enjoy good tax-break.

Doubt if such possibility exists/allowed when rental property held in IRA. (dunno- do check)

much harsher aspect is trying to take RMDs on highly illiquid and highly brittle (ie., one can’t easily sell in smaller chunks/piecemeal)

Now - calling this out as a problem on RMDs — this sounds like words parody!

May be a we should term this particular variation of self-directed IRA, instead as: self-inflicted IRA !

Any tax-experts in the BH house !?

[Lee_WSP]

I’ll be honest. I’d probably have to charge something similar to create LLCs or LLPs to put the properties in and then do in kind distributions of those shares.

[Wymo56]

There are 3 properties and all are in an LLC. Help me understand your point. Thx.

[jebmke]

Imo, the important thing is to reframe it; it’s not a tax torpedo, it’s deferred taxes becoming due.

Charity and Roth conversions are the usual go-to fixes, but it should probably read “fixes.”

We were once worried about RMDs; in the intervening years, our good fortune made us realize QCDs can be a good way to give.

Same here; in fact, once we reached a conclusion that it was likely that our entire estate would go to charity I stopped Roth conversions entirely.

Whenever I get to an apparent issue or decision point, I try to zoom out in my mind and frame the entire financial picture, short and long term including estate/legacy plans. The older you get, the more it all integrates together.

[toddthebod]

There are 3 properties and all are in an LLC. Help me understand your point. Thx.

You distribute ownership shares of the LLC to cover the RMD.

[Lee_WSP]

There are 3 properties and all are in an LLC. Help me understand your point. Thx.

You need to be able to split up the properties into tax efficient chunks. One way is to create shares and distribute those in kind. No matter what, that’s going to be expensive and involve a ton of accounting and valuations.

But the better way is to sell it to yourself and swap high basis liquid positions you have for the properties/property and then you can distribute those. If you’ve got enough to buy out one property, you can probably rinse and repeat three times.

Eventually, the IRA must be emptied.

[Katietsu]

Q3 advisors seem to just to give a plan for how much to Roth convert each year for optimal tax savings (based on their set of assumptions) for the $9300. I doubt the $9300 includes any of the extra work involved with addressing the real property inside that IRA that Lee_WSP is proposing.

[bsteiner]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

What's the tax bomb? You got the benefit of the income and gains on your share (1 minus the tax rate) of your IRA being tax-free for many years. But Congress mandated that you take distributions at a certain point.

The only way to "avoid" taxes is to give (in the form of QCDs to the extent permissible) or leave the IRA benefits to charity.

For IRA benefits you don't plan to give or leave to charity, Roth conversions are generally beneficial to the extent you can convert at a tax rate less than, equal to, or not too much higher than the tax rate that would otherwise apply to the distributions, especially if you can pay the tax on the conversion out of other money. If you're retired and you won't have to take RMDs for another 6 years or Social Security for another few years, you may have a window when you can convert at a lower bracket.

What's an "advisor?" Someone who didn't pass the bar exam?

Dealing with real estate in an IRA is complicated.

[MrBobcat]

Can you buy the property personally (at FMV), get the rentals out of the IRA and cash into the IRA?

[bsteiner]

Can you buy the property personally (at FMV), get the rentals out of the IRA and cash into the IRA?

That would be a prohibited transaction (self-dealing) under Internal Revenue Code Section 4975: https://www.law.cornell.edu/uscode/text/26/4975. The IRA would cease to be an IRA. Section 408(e)(2): https://www.law.cornell.edu/uscode/text/26/408.

However, you could apply to the Department of Labor for a prohibited transaction exemption. You can find the prohibited transaction exemptions that have been issue here: https://www.dol.gov/agencies/ebsa/laws- ... individual.

[Wymo56]

[Thread merged into here --admin LadyGeek]

I'm hoping the combined wisdom of the community can help me.

KA (64 years old) and I (67 years old) are both retired. We have no employment income.
Our income in 2023 is $35k comprised of Interest (~$22k) and IRA Distributions (~$13k). This is artificially low for ACA purposes. KA will join me on Medicare in March of 2024.

We are not receiving SS and plan to wait until I am 69+ when KA is at full retirement age. Combined SS annual income will be around $67K ($44.5k + $22.5K spousal benefit).

We have $375k after tax saved (and thus the Interest income above) for a house down payment, home furnishings and an emergency fund. Our expenses will increase in 2024. (I estimate income of $60k to $70k mostly from distributions.) We travel in an RV full time. No dependents. We are debt free. We file a Joint tax return.

KA has $150k in a Self-Directed IRA. I have $1.1M in a Self-Directed IRA comprised of 3 rental properties (valued at $750k) and more liquid assets in mostly debt instruments ($325k). The properties make about $50k a year in profit. They conservatively appreciate at 3% annually. The debt instruments are earning about 8% annually.

I am considering partial Roth conversions beginning in 2024 to cut RMDs in half and give the remaining RMD to charity or pay taxes on it, if needed.

I recently purchased Pralana Gold in hopes of putting a conversion plan together. The learning curve with Pralana will be time consuming.

Short of that, does the scenario above sound like I am a good candidate for Roth conversions?

Thanks in advance for any advice!

[Manny1066]

I am not sure how you would convert a self-directed, traditional IRA that contains expensive real-estate in it to a Roth without incurring a big tax bill

are you asking if you should take the 750k in the IRA and convert it all? Or maybe a 3rd of it?

That could be a $200,000 tax bill

how would RMDs even work in this scenario? Real estate isn't liquid. Would you have to sell one of the properties?

I'm leaving this one to the accountants lol

[White Coat Investor]

I am considering partial Roth conversions beginning in 2024 to cut RMDs in half and give the remaining RMD to charity or pay taxes on it, if needed.

These are NOT good reasons for Roth conversions. If you're willing to give your RMDs to charity and leave your IRA to charity, it would be a huge mistake to do a Roth conversion on it.

When we realized a few years ago that our tax-deferred accounts were smaller than the amount we planned to leave to charity we determined that we would probably never do a Roth conversion.

Roth conversions are to minimize the tax rate for money you'll spend or for heirs that are in a higher tax bracket than you, not just to dodge RMDs.

Not a fan of equity real estate in retirement accounts either. Gets messy with UBIT, RMDs, capital calls etc. Plus what's the point of all that depreciation?

[livesoft]

I was looking at our Roth conversion strategy today. We have 2 things different from OP:

a. No interest income. Instead we have qualified dividend income that is taxed at 0% or 15% depending on our income.

b. We bunch deductions so that we take the standard deduction every other year and in the alternate year we donate a lot to our donor-advised fund. Basically, by donating we get a tax-free Roth conversion for a big chunk of that converted amount.

[PeninsulaPerson]

What's a KA?

[MarkVH0518]

I've been juggling these same balls, but mine are of somewhat different sizes.
My experience is that there are so many knobs and buttons it's impossible the navigate this perfectly.
So, allow me to propose two boundary conditions for evaluation.
If one of these conditions applies, then the decision is somewhat easy.
Otherwise, it's kind of like flipping a 10-sided coin; it's really tough to decide.

1) If you plan the give away your RMD's, then, as White Coat Investor suggested, Roth conversions are a mistake.

2) If you plan to give away *less* than your RMD, then perform a tax calculation assuming the following:
-) you are subject to the Social Security Tax Torpedo
-) the Trump-era tax cuts expire.
-) determine your 2023 (or 2024) tax bracket assuming you receive ACA subsidies
(FYI: in 2022, my tax bracket was 33% after consideration of ACA subsidies)

Then compare the two tax brackets and decide if you should execute some Roth conversions.

It will probably require a couple hours with your tax software (be sure to purchase on Black Friday), but
your decision will be based upon, at least, some realistic data.
And if you manage something even close to my suggestion, be proud! Few can evaluate this problem, say nothing of optimization.

Good luck
Mark

[LadyGeek]

Wymo56 - In order to provide appropriate advice, it's best to keep all the information in one spot. I merged your update back into the original thread. If you have any questions, ask them here.

(Thanks to the member who reported the post and provided a link to this thread.)

[Wymo56]

b. We bunch deductions so that we take the standard deduction every other year and in the alternate year we donate a lot to our donor-advised fund. Basically, by donating we get a tax-free Roth conversion for a big chunk of that converted amount.

[ quote fixed by admin LadyGeek]

Livesoft, Can you explain this to me? ( Iam not familiar with a donor-advised fund.) It sounds like, you donate after tax money to charity and apply the tax deduction against the taxes from a Roth conversion, yes?

[LadyGeek]

The wiki has some background info: Donor advised fund

[White Coat Investor]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

The RMD at 75 on a $1.2 million IRA is only $48,760. How big of a "tax bomb" can that possibly be? If we assume that SS is filling your standard deduction and 10% bracket, you're only paying 12% or so on that $50K. So....$6K. You're going to pay someone $9K just to help you do a Roth conversion to avoid a $6K tax bomb? Seems penny wise and pound foolish.

That said, this is one reason why I think it's foolish to have equity real estate in an IRA. If there aren't enough liquid assets in that IRA or enough income coming from the properties to do the RMDs you could be forced to sell property you wouldn't otherwise sell.

A Roth conversion is fine if you've got $500K sitting around to pay the taxes on it. That sounds like a tax bomb to me. I don't think you HAVE to sell the house(s) to do a Roth conversion.

[livesoft]

b. We bunch deductions so that we take the standard deduction every other year and in the alternate year we donate a lot to our donor-advised fund. Basically, by donating we get a tax-free Roth conversion for a big chunk of that converted amount.

[ quote fixed by admin LadyGeek]

Livesoft, Can you explain this to me? ( Iam not familiar with a donor-advised fund.) It sounds like, you donate after tax money to charity and apply the tax deduction against the taxes from a Roth conversion, yes?

A Donor-Advised Fund is a charity. One can donate to charity and if one itemizes, then some or all of that donation can be used to offset income. See Form 1040 (your tax return). Since a Roth conversion adds income to your tax return (once again see Form 1040), a donation to charity may offset that income. That is, the tax deduction is not applied against the taxes from a Roth conversion, but against the income of the Roth conversion.

There are other complications such as making sure to have enough total legitimate deductions to get way above the standard deduction. For example, if the standard deduction was $28,700, then it makes no sense to have less than $28,700 of itemized deductions, but it makes sense to have $50,000 of itemized deductions. See Form 1040 Schedule A for more information.

[Geologist]

b. We bunch deductions so that we take the standard deduction every other year and in the alternate year we donate a lot to our donor-advised fund. Basically, by donating we get a tax-free Roth conversion for a big chunk of that converted amount.

[ quote fixed by admin LadyGeek]

Livesoft, Can you explain this to me? ( Iam not familiar with a donor-advised fund.) It sounds like, you donate after tax money to charity and apply the tax deduction against the taxes from a Roth conversion, yes?

A Donor-Advised Fund is a charity. One can donate to charity and if one itemizes, then some or all of that donation can be used to offset income. See Form 1040 (your tax return). Since a Roth conversion adds income to your tax return (once again see Form 1040), a donation to charity may offset that income. That is, the tax deduction is not applied against the taxes from a Roth conversion, but against the income of the Roth conversion.

There are other complications such as making sure to have enough total legitimate deductions to get way above the standard deduction. For example, if the standard deduction was $28,700, then it makes no sense to have less than $28,700 of itemized deductions, but it makes sense to have $50,000 of itemized deductions. See Form 1040 Schedule A for more information.

Another complication is that donations of appreciated property are limited to 30% of adjusted gross income (AGI). The OP has not been describing very high annual income, so a $50,000 donation might well exceed the 30% limit. While the value can be carried over to future years, the charitable donations may not then exceed the standard deduction in the later year.

[Artsdoctor]

Need some advice. I am 6 years away from RMDs from my Self Directed Traditional IRA. The majority of the assets in the IRA is rental property. The portfolio is about $1.2 million. What are my options to avoid taxes, especially considering the growth potential of the portfolio by rent and property appreciation? I have spoken with an advisor (Q3 Advisors, LLC) who is recommending an accelerated Roth conversion. Their fee is $9300! To pay the taxes from the conversion would require some liquidation of property(s). What other tax avoidance products are out there? I know there would not a tax problem IF I gave the RMD to charity but to do so would probably require some liquidation of the property(s). Any thoughts? Can you point me to some pertinent posts? Thank you!!

The RMD at 75 on a $1.2 million IRA is only $48,760. How big of a "tax bomb" can that possibly be? If we assume that SS is filling your standard deduction and 10% bracket, you're only paying 12% or so on that $50K. So....$6K. You're going to pay someone $9K just to help you do a Roth conversion to avoid a $6K tax bomb? Seems penny wise and pound foolish.

That said, this is one reason why I think it's foolish to have equity real estate in an IRA. If there aren't enough liquid assets in that IRA or enough income coming from the properties to do the RMDs you could be forced to sell property you wouldn't otherwise sell.

A Roth conversion is fine if you've got $500K sitting around to pay the taxes on it. That sounds like a tax bomb to me. I don't think you HAVE to sell the house(s) to do a Roth conversion.

Of course you're right on several points. Real estate in an IRA is a problem for all of the reasons the OP and you point out.

One slight quibble with the math, though. You're assuming a MFJ tax filing status, which is reasonable. But for an individual the marginal tax rate with the RMDs and not-so-extravagant interest from a taxable account would probably be in the 22% bracket or thereabouts. Definitely not a tax bomb, but more than the 10-12% marginal you rate you mentioned. MFJ filing status may not last forever so sooner or later, the OP will need to consider some more tax planning techniques.

[celia]

OP, you appear to have a self-directed IRA at a custodian who specializes in these. You aren't the first person to be in this situation, so you should talk to the custodian to see what your options are.

One thing you might be able to do if you have other IRAs is take the total of a year's RMDs from the "other" IRA. But that will work only so long.

Another thing is to remove one building a year. That will withdraw a lot more than your RMD and maybe this could be a Roth conversion instead. (You will never have to withdraw from a Roth IRA--under current law.) The advantage of staying in a Roth is all that future tax-free rent you will get.