DREIA

For over 15 years the Morris family vacationed in a beachside community in South Carolina, each time staying in the same condominium complex, renting from various owners. Traditionally, after releasing the children to the beach, they would grab the local real estate guide, noticing the unit prices going up each year. Nearby, they discovered that there were a few vacant lots available – and since their savings was not sufficient to purchase the condo units, they started looking into purchasing raw land as an investment.

The Morriss were fortunate to have recently attended an Entrust presentation on self-directed IRAs which provided step-by-step instructions on how to purchase investment real estate with their retirement funds. John Morris subsequently opened a traditional IRA with Entrust, then rolled over his existing 401k funds.

During one vacation period, they worked with a local realtor, selected a buildable lot, then directed Entrust to purchase the property in the name of their IRA: Entrust FBO (for the benefit of) John Morris IRA. Once the $100,000 transaction was completed, the property was then owned by the IRA, with the IRA being responsible for all taxes and HOA fees.

Although they were happy with their IRA investment, John remembered that during the Entrust presentation that he was told that IRA investments must be passive, and that the IRA beneficiary cannot gain any use from the property. The rub was that John’s wife, Joan, had a dream of retiring to this seaside community, building on the IRA owned land, and living the good life. John reminded her that the dream would likely be very expensive, as to use his IRA owned property, they would have to take a taxable distribution on the property first – at the then appraised price (assuming that the property would double in the intervening years before retirement, the tax rate would be ordinary income of $200,000).

Roth Conversions

Adjusted Gross Income must be $100,000 or less in order to convert
Ordinary Income tax due on the converted amount no later than April 15th following the year of conversion
To avoid penalty and taxes on Roth withdrawals:
- Must have a Roth account funded for at least five years and…
- Be at least 59.5 years old

After listening to Joan’s pleas – John took the step of contacting his CPA to see if there were any ways to transition the property from the IRA to personal use and avoid the $200,000 tax liability for distribution. After studying John’s and Joan’s earnings and personal finances, he suggested that John convert his traditional IRA to a Roth. John qualified for the conversion due to the fact that his adjusted gross income for the year for him and his wife was less than $100,000. Based on his CPA’s recommendation, John converted his traditional IRA, and thus on his tax return, his income was increased by $100,000 for the year (the property was converted to a Roth soon after purchase, otherwise an appraisal would have been required prior to conversion), and he paid the resulting taxes by April 15th of the year following the conversion.

What was the benefit to John (and Joan) for paying the taxes and converting a traditional IRA to a Roth? First, the appreciation of the land will continue to grow tax deferred, much as it would in a traditional IRA. However, Joan’s dream of building and living on the land now owned in a Roth IRA can be economically realized.

Once John has funded a Roth account for five years, and has achieved the age of 59.5 years, he can take a distribution of the land from his Roth IRA without tax consequences. After taking the distribution, the Morris’ have full use of the land for any lawful purpose, including as a domicile. If he had not converted to a Roth IRA soon after purchasing the land with his traditional IRA, John would have faced large tax consequences at the very time he and Joan would need the personal resources to build their retirement home.

Whether you should or indeed can convert from a SEP, Simple or a Traditional IRA to a Roth is a very personal decision, one which is best reached through a consultation with your CPA or tax professional. The real power lies with self-directing your IRA with Entrust, regardless of the investment account you choose – as your choices are limited only by the IRS, not your administrator.

Glen Mather is Director of Entrust Administration Services, Inc. and is a Corporate Member of DREIA. He can be reached at (877) 259-3256 or gmather@entrustfl.com.