How can I figure out if IRA to Roth conversion is worth it?

[ERICOPOLY]

You are probably correct in that there will be no taxes on the Roth in the future, but talk  to some folks who invested in real estate and then found in the 80's that congress changed the rules and they couldn't deduct their losses.

Also if they put in a VAT then you could be indirectly taxed.

 

That's true about "some" folks with regard to real estate.  However others never experienced that.  For example, I invested in rental housing in the early 2000s and I deducted all of my passive real estate losses against my Microsoft income, without limits to the amount, for a couple of years before I sold my properties. 

 

The trick is that either you or your wife needs to earn the designation of "Real Estate Professional".  The funny thing is, the rental were mine, but I got the write-off anyways given that I was married to a "Real Estate Professional".  Here is a recent article about the technique:  http://www.inman.com/2012/09/14/real-estate-pros-can-deduct-rental-losses/

 

 

Thanks Eric, I didn't know this till now. I am certified realtor but my number of hours as relator is not that much as i have  a full time job. I recently found bargain rental property in my neighbourhood and bought it, will close it this week. I will see if i can use this special clause. When you say loss,Are you talking after depreciation ? if i can't count depreciation then i will be making a profit as it will generate +ve cash flow on this property.

 

The IRS has some rule that doesn't let "rich people" deduct rental losses against earned income once their income passes beyond a certain threshold. 

 

So if repairs+taxes+depreciation+expenses exceed your gross rental receipts, you have a loss that possibly can't be deducted against your earned income.  In my case, I probably had $20,000 or so in annual losses that I could write off against my Microsoft income.  It made a big difference. 

 

The game is to leverage those properties as much as possible until they generate losses that you can use to offset your earned income from your job.  You are basically, over the long run, recouping those losses through inflationary asset value increases of your properties.  Total return is what matters.

 

So it's awesome when you can get 100% financing, zero money down real estate investments.  That way you don't tie up your cash in property, and you get a tax shelter against your earned income, and the capital gains from the properties are all gravy on top that far exceeds the annual cash that you have to pump into it.  Or if the "losses" merely come from paper depreciation, all the better.  It can be "losing money" on paper even when it's cash-flow neutral.

 

Further down the road, the property has appreciated and you then tap that equity with another loan.  This loan can be spent tax-free of course -- because when you die the property gets a step-up in cost basis.  So you've converted taxable income into tax-free money.

[locatevalue]

Eric, Thats what i am doing its a cash auction deal so i am using a margin loan but planning to get it financed as much and as soon as possible. I can only refinance upto 75% of purhcase price till 1 year then will get the remaining as equity loan if intrest rates went up or refinance if its still cheaper but the plan is to free up equity as much as possible. Now i need to see what "rich people" mean i dont feel rich by any standards ,jut a normal 2 income family with some accumulated trade asserts.

[Mephistopheles]

Ericopoly - do you know of any companies that will set up the variable annuity structure but allow for investments in individual stocks?  It would be much more appealing if I didn't have to invest in a mutual fund.

 

I looked a while back and couldn't find any that allowed you to manage the investments yourself -- you get stuck choosing from mutual funds or bond funds.

 

The variable annuities are famous for being expensive in terms of fees, which is why I was careful to point directly to Vanguard's site.  They are very inexpensive relative to most.  It's about 50 basis points in total all-in fees for their bond or REIT funds wrapped in variable annuity.  That's relatively high for a vanguard fund, but they know they have you over a barrel because your alternative is perhaps paying very high marginal tax rates annually.  However with these very low interest rates the expense becomes a high percentage of the actual gains -- it's a bit silly.

 

But I think if you were going to go that route, it would be better to do it with income funds that generate investment income that is normally taxed at the high personal income rate -- one that is high because you perhaps are also working at the same time.  Then later when you retire your tax rate will be lower.  So you use it as a tool to lower your effective tax rate, and of course you get the valuable deferral of the taxes.  Especially useful if you are working at a career in California but plan to retire in a state with no income tax -- although in that case the RothIRA conversion doesn't make as much sense.

 

But since we're talking about somebody else's parents, I figured the words "mutual funds" or "bond funds" are likely what they want anyhow.  So the investment restrictions of variable annuities aren't that bad for them.

 

Well even though it's my parents I'm the one who manages all their funds and will continue to do so in the future, and so I am all for the stock picking and against mutual/bond funds. Too bad these annuities don't allow buying individual stocks.

[ERICOPOLY]

See, let's say for argument's sake that you are already fully invested in your taxable account.  Then you borrow a bit of money against it and put the borrowed money into a variable annuity bond fund.  So now you are leveraged and paying margin interest.  Which for large loans is only 50 bps at IB, and will be higher at some point in the future. 

 

Then you wait a month (to avoid wash sale rules) and you then short the same type of bonds in your taxable account.  So you no longer have a net leverage position.

 

Given that you are short the bonds in a taxable account, you should be generating quite a bit of investment expense.  At a high tax bracket this could be of value from a taxable investment income sheltering perspective.  Meanwhile, you have bond income compounding tax-deferred in your variable annuities.

 

So in a sense you are doing this as a means of sheltering your individual bond picking from annual taxation.  See, if you already like to purchase bonds or REITs that you think are undervalued, but you hate paying the annual tax on them, then this might be of value to you.

 

In an upside-down way you are using the variable annuity as a means of picking individual bonds in a manner where the income from such bonds is tax-deferred.

 

And those investment expenses (the bond interest that you pay to others for your short bond position) could also be written off (I think) against perhaps your income from real estate properties if you have any.

 

"Officially" you are just shorting the bonds in the taxable account to hedge your individual bond picking -- nothing suspicious about that.

[bookie71]

Let's see you deducted $20K, but if you had a major repair or losses of $ several hundred thousand K then you could only deduct about 25K.  If you were playing by old rules and Congress changed the rules retroactive then you were screwed.

[ERICOPOLY]

Let's see you deducted $20K, but if you had a major repair or losses of $ several hundred thousand K then you could only deduct about 25K.  If you were playing by old rules and Congress changed the rules retroactive then you were screwed.

 

That was just poor luck for some people.  It could have gone the other way too -- their tax shelter could have been upheld and instead tax rates could have gone back to their peak of 92%.

 

It happened to people who couldn't claim they met the "Real Estate Professional" test.  The NAR (I presume it was them) made sure that it didn't apply to realtors -- perhaps Congress got all mixed up and thought it was just a typo -- I sure as hell wouldn't want a bunch of angry NRA folks after me  :D

 

However if you don't have a shelter like that you get stuck paying more taxes year after year.  So it's no sure thing, but it will work for at least a while.  And it still works today for anyone that's a Real Estate Professional (under the IRS rules). 

 

 

[locatevalue]

Let's see you deducted $20K, but if you had a major repair or losses of $ several hundred thousand K then you could only deduct about 25K.  If you were playing by old rules and Congress changed the rules retroactive then you were screwed.

 

That was just poor luck for some people.  It could have gone the other way too -- their tax shelter could have been upheld and instead tax rates could have gone back to their peak of 92%.

 

It happened to people who couldn't claim they met the "Real Estate Professional" test.  The NAR (I presume it was them) made sure that it didn't apply to realtors -- perhaps Congress got all mixed up and thought it was just a typo -- I sure as hell wouldn't want a bunch of angry NRA folks after me  :D

 

However if you don't have a shelter like that you get stuck paying more taxes year after year.  So it's no sure thing, but it will work for at least a while.  And it still works today for anyone that's a Real Estate Professional (under the IRS rules).

 

 

It still works, I see some smart real estate professionals using these and pass on equity tax free using step-up and 1031 exchanges even though they claim these depreciations and repairs on upgrade as expenses every year, The trick is to find great properties and not to sell, even if you want to sell , if you can reside in that house for 2 years you dont have pay tax on gains. Its all perfectly valid and legitimate if you follow IRS rule book. Eric as you said NAR spend lot of money for lobbying and they have  a good clout in congress. The only reason i got this license is for Investment pruposes and haven't use it much till now  , but plan on using this going forward.

[ERICOPOLY]

The only reason i got this license is for Investment pruposes and haven't use it much till now  , but plan on using this going forward.

 

I'm liking that thought.

 

[bookie71]

We are talking about totally different things.

[ERICOPOLY]

We are talking about totally different things.

 

Oh.  I was talking about writing off real estate losses against a person's earned income.  That is something that was popular and then closed in the 80s.  So when you mentioned something that was closed in the 80s, that's what I thought you meant.

 

Only... it was not closed for everyone (just for most people)... they left in a provision for "Real Estate Professionals".

 

Under those old rules (and still today for Real Estate Professionals), you can deduct millions if you want against your active income.  Or you can deduct billions or trillions -- well... what I mean is there isn't a limit.

 

Additionally, I think you need to play an "active" role in the management of the property -- if you hire a property manager then I think you lose the ability to write it off against anything but passive income (so not your earned income from your job).

[ERICOPOLY]

We are talking about totally different things.

 

I don't believe you specifically stated what it is that you are talking about -- I genuinely want to understand.  I still think you're talking about the $125,000 household income ceiling, above which you can't deduct excess real estate expenses against your earned income.

 

Are you talking about something other than that?

[smreitz]

We are talking about totally different things.

 

I don't believe you specifically stated what it is that you are talking about -- I genuinely want to understand.  I still think you're talking about the $125,000 household income ceiling, above which you can't deduct excess real estate expenses against your earned income.

 

Are you talking about something other than that?

 

For most individuals rental activities are passive and they cannot deduct the rental losses at any income level. The losses are carried over until there is passive income to offset the losses or the rental property is actually sold (the losses are 'freed-up').

 

Individuals can classify themselves as either:

 

a. Passive (see above);

b. Active (this is where the special $25,000 special allowance comes into play, see below);

c. Real estate professional (can deduct rental losses fully).

 

The above 3 categories have of course different requirements.

 

When individuals label themselves as active, meaning they own at least 10% of the rental property and have substantial involvement in managing the rental, they are allowed the special $25,000. The allowance is reduced by 50% of the amount by which the taxpayer's modified adjusted gross income (AGI) exceeds $100,000. Thus the allowance is reduced to zero when AGI reaches $150,000.

 

I hope that helps clarifies some of the issues discussed in the thread about the rental losses.

 

 

 

[Kiltacular]

Real estate professional (can deduct rental losses fully).

 

I would appreciate color from anyone with more knowledge of the above. 

 

Does anyone have experience doing this?  If there aren't specific standards set from the IRS, I'd be interested in comments from anyone who does this.

 

Do states with income taxes go with the IRS?

 

 

 

 

[ERICOPOLY]

Real estate professional (can deduct rental losses fully).

 

I would appreciate color from anyone with more knowledge of the above. 

 

Does anyone have experience doing this?  If there aren't specific standards set from the IRS, I'd be interested in comments from anyone who does this.

 

Do states with income taxes go with the IRS?

 

 

As mentioned above, I made this Real Estate Professional election when I owned two rentals in Seattle area.

 

There was no limit to what I was allowed to deduct.

 

My wife was a full-time realtor.  I owned the rentals.  We managed them ourselves (no property manager).  We did 100% of the work in advertising the property, securing the tenants, responding to them, etc...

 

[smreitz]

Real estate professional (can deduct rental losses fully).

 

I would appreciate color from anyone with more knowledge of the above. 

 

Does anyone have experience doing this?  If there aren't specific standards set from the IRS, I'd be interested in comments from anyone who does this.

 

Do states with income taxes go with the IRS?

 

 

 

 

 

Real estate professionals must treat rental real estate activities in which they materially participate as non-passvise activities. Therefore, they can deduct these rental real estate losses from other non-passvie income. The $25,000 special allowance does not apply to these taxpayers.

 

Real estate professionals are individuals who meet both these conditions:

 

1. More than 50% of their personal services during the tax year are performed in real property trades or businesses in which they materially participate (Most individuals can meet material participation requirements by satisfying one of the seven testes discussed here: http://www.forbes.com/sites/robertwood/2012/02/02/why-material-participation-can-be-your-ticket-to-tax-deductions/) and,

 

2. They spend more than 750 hours of service during the year in real property trades or business in which they materially participate.

 

To meet the tests in items 1 and 2, above, taxpayers can elect to treat all interested in rental real estate as one activity. The election is made by filing a statement with the original return.

 

State income tax note: Check with your particular state whether they acquiesce with the Federal IRS's rules. For example, California does not fully conform.

[Kiltacular]

Thanks Ericopoly and smreitz

 

 

[Mephistopheles]

See, let's say for argument's sake that you are already fully invested in your taxable account.  Then you borrow a bit of money against it and put the borrowed money into a variable annuity bond fund.  So now you are leveraged and paying margin interest.  Which for large loans is only 50 bps at IB, and will be higher at some point in the future. 

 

Then you wait a month (to avoid wash sale rules) and you then short the same type of bonds in your taxable account.  So you no longer have a net leverage position.

 

Given that you are short the bonds in a taxable account, you should be generating quite a bit of investment expense.  At a high tax bracket this could be of value from a taxable investment income sheltering perspective.  Meanwhile, you have bond income compounding tax-deferred in your variable annuities.

 

So in a sense you are doing this as a means of sheltering your individual bond picking from annual taxation.  See, if you already like to purchase bonds or REITs that you think are undervalued, but you hate paying the annual tax on them, then this might be of value to you.

 

In an upside-down way you are using the variable annuity as a means of picking individual bonds in a manner where the income from such bonds is tax-deferred.

 

And those investment expenses (the bond interest that you pay to others for your short bond position) could also be written off (I think) against perhaps your income from real estate properties if you have any.

 

"Officially" you are just shorting the bonds in the taxable account to hedge your individual bond picking -- nothing suspicious about that.

 

That's a creative idea. A couple of questions though. Why do I need to go into margin to do this? Can't I just invest, say, $50k into an annuity (or whatever the limit is), and short $50k of the same bond fund? Also, what about the cost of borrowing to short and the cost of the margin borrowing (if the margin does in fact make sense)? Why is it still worth it after paying those fees, especially when rates go up?

 

Edit: In case it helps, my parents are in the 28% federal bracket and 6.37% state bracket

[ERICOPOLY]

See, let's say for argument's sake that you are already fully invested in your taxable account.  Then you borrow a bit of money against it and put the borrowed money into a variable annuity bond fund.  So now you are leveraged and paying margin interest.  Which for large loans is only 50 bps at IB, and will be higher at some point in the future. 

 

Then you wait a month (to avoid wash sale rules) and you then short the same type of bonds in your taxable account.  So you no longer have a net leverage position.

 

Given that you are short the bonds in a taxable account, you should be generating quite a bit of investment expense.  At a high tax bracket this could be of value from a taxable investment income sheltering perspective.  Meanwhile, you have bond income compounding tax-deferred in your variable annuities.

 

So in a sense you are doing this as a means of sheltering your individual bond picking from annual taxation.  See, if you already like to purchase bonds or REITs that you think are undervalued, but you hate paying the annual tax on them, then this might be of value to you.

 

In an upside-down way you are using the variable annuity as a means of picking individual bonds in a manner where the income from such bonds is tax-deferred.

 

And those investment expenses (the bond interest that you pay to others for your short bond position) could also be written off (I think) against perhaps your income from real estate properties if you have any.

 

"Officially" you are just shorting the bonds in the taxable account to hedge your individual bond picking -- nothing suspicious about that.

 

That's a creative idea. A couple of questions though. Why do I need to go into margin to do this? Can't I just invest, say, $50k into an annuity (or whatever the limit is), and short $50k of the same bond fund? Also, what about the cost of borrowing to short and the cost of the margin borrowing (if the margin does in fact make sense)? Why is it still worth it after paying those fees, especially when rates go up?

 

Those are good questions -- and whether or not the tax savings is larger than the extra expense depends on the interest rate the bonds pay as well as the tax rate. 

 

The scenario I had in mind should have low borrow expenses.  I was thinking to short muni bonds and allocate the variable annuity in taxable highest-rated bonds (higher yields than tax-exempt munis).

 

Muni bonds trade with lower interest rate because the yields are tax exempt.  Thus I thought I could capture that spread to help defray the other costs.