Retirement
Roth conversion vs rental property: which saves more?
A short, direct comparison. Why a conversion adds to the income that drives your aid number, and what the same money does in a property instead.
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Why not simply do a Roth conversion
Okay, in this video I want to talk about why you shouldn't do a Roth IRA conversion. >> [music] >> I'm Kevin Harrington, an original shark from Shark Tank. I recommend these unique strategies. >> [music] >> Now you've probably heard a lot about Roth IRA conversions, and when we help our clients minimize their taxes, the first question that that comes up is should I do a Roth IRA conversion?
Now we all know that taxes are probably going to go up in the future. If you were to ask 100 people, 99 out of 100 are going to think that taxes are going to go up in the future. So everyone wants to do a Roth IRA conversion because they want to pay the government now instead of later. Now I'm going to give you something else to consider, and why you might want to consider another option instead of a Roth IRA conversion.
So for example, let's say over here we have an income of $300,000. Now let's say that we help you implement some tax strategies, and we show you how to get that income to zero. So now all of a sudden, we're going to reduce your income by $300,000, and your income is now zero. So the obvious thought is is correct.
It's like, "Hey, my income is zero. Now I could take some money over here out of my IRA. Let's say I have $300,000 in my IRA." So you think, "Okay, I'm going to take $300,000 out of my IRA, okay? But to do that, it is going to add $300,000 to your income.
So, you've just increased your income by $300,000 again. Now, yes, it's true. It's better to pay taxes on that $300,000 of income and not $600,000 cuz you would be in a higher tax bracket and your effective
What converting adds to your income
tax rate would be higher. So, yes, it's a good idea to consider taking money out of an IRA, if this is our IRA. It's a good idea to consider taking money out of your IRA when your taxes are going to be low. However, by moving money from an IRA to a Roth IRA, it only allows you to pay the taxes now and not have to pay a 10% penalty.
So, you are going to save the money of $30,000, okay? There's There's no $30,000 10% penalty because you're paying your taxes now and you're doing a Roth conversion, which is allowed without a penalty. So, you're saving that $30,000 penalty. you are still going to have to pay the taxes out of your pocket, not out of the IRA money, out of your pocket.
You've got to come out of your pocket to pay the taxes on that $300,000. Now, if you instead put $300,000 from your IRA into a short-term rental or what we call a scholarship house or a vacation rental, okay, and you qualify for what we call bonus depreciation, and if you use that $300,000 as 30% down on the house, because let's say you put 10% down on the house and another 20% into furnishings and remodeling and the theme and some sort of creating an experience and an Airbnb. That allows us to buy a $1 million vacation rental for $300,000. Okay?
Now, if you get what they call a cost segregation study, you're going to be able to look at that million-dollar property and identify what could be depreciated in 1 year because of bonus depreciation. And on average, it's around 30% ironically. I like easy math, okay? So, now we buy this million-dollar house and because of a cost segregation study and because of bonus depreciation, I'm able to
Ten percent down, and what furnishes it
offset my income by $300,000. So, when I took $300,000 out of my IRA, it added it to my income, right? It added it to my income and it added $30,000 in a penalty if I'm not 59 and 1/2, okay? But now, I just bought a short-term rental.
Instead of paying all the taxes on that, I get a tax break from the government of $300,000. So, that $300,000 crosses out the $300,000 that I increased my income. So, now the only thing I have left is my penalty. However, this could start generating cash flow.
We We give you an 8% minimum or 50% of the revenue, whichever is greater if you partner with us. So, now you can get an 8% annual cash flow on your $300,000 investment. And if you think about the next 10 years, that could be a few hundred thousand dollars or two hundred thousand dollars that is going to offset that $30,000 penalty. And you could use that cash flow to pay for college.
So, the beauty of using the IRA to buy a short-term rental instead of buying a Roth IRA is that you generate tax savings by purchasing a short-term rental. You don't generate tax savings when you buy a Roth IRA or you convert your IRA to a Roth IRA. All you're doing is paying your taxes now instead
What the next ten years look like
of later when we assume they're going to be higher, but how about you just take advantage of the current tax benefits and not pay your taxes at all. Just don't have to pay taxes at all because you use the tax savings to offset the increased taxes. If you have any questions, book a call with our team in the link below and we will show you a better option instead of doing a Roth IRA conversion, which is purchasing a short-term rental.
Educational information only
This is a transcript of a recorded presentation, edited only for paragraphing. It is general educational information, not tax, legal or investment advice, and it does not take account of your circumstances. Tax law changes and outcomes depend on your own facts. Figures mentioned are illustrations of how a strategy works, not projections of what you will receive. Confirm your position with your own CPA or tax attorney before acting.
Questions this raises
Why would a Roth conversion be a problem during college years?
Because the amount you convert is added to your income for that year. Income is the largest input in the aid formula, so a conversion in a filing year can raise the number the formula produces at precisely the wrong moment.
Is a Roth conversion a bad idea generally?
Not at all. It is a well-established way to pay tax now at a known rate instead of later at an unknown one. The argument here is about timing against college years, not about whether conversions are sound.
What is the alternative being compared?
Putting the same money toward a property instead, where a deposit plus furnishing costs buys an asset that produces a deduction in year one and income afterwards, rather than producing a tax bill now.
Does the property option require more involvement?
Yes, materially so. A conversion is a form and a wire. A property is a purchase, a renovation, guests and a material participation test. The comparison is not only about numbers.
Which one suits a family not seeking financial aid?
The aid objection falls away, which removes the timing argument against converting. What remains is a straightforward comparison of what each does to your tax position and your estate, and that is a conversation for your own advisor.
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