So, you’ve diversified your retirement account and invested in real estate in an offshore IRA. . .great. Now you need to take a distribution, what should you do? In this article, I will describe how to distribute real estate in an offshore IRA.
Rental real estate in an offshore IRA is one of the highest returning investments my clients have. The problem is, the primary asset can’t be divided up and sold to pay any taxes due on required distributions when you turn 70 ½ or at another age to reduce your net tax rate.
The same problem occurs when you decide you want to live in the property. To spend even one night in the home, you must distribute all of it from your account.
Note: One of the most common and reasonable questions I get is, “If I want to spend 2 weeks a year in the rental property, can I pay fair market value rent or take a distribution of 2/52nds (2 weeks out of 52 weeks in a year) of value?” The answer is a resounding NO. You may not spend any time in the property while it’s in your retirement account. The fact that the real estate is in an offshore IRA makes no difference – you must follow the same rules.
With this in mind, before you buy real estate in an offshore IRA, plan ahead for the forced distributions or the complete distribution if you plan to live in the property someday. This means you must have the cash in savings or in other liquid IRA investments to cover the taxes due.
Of course, if the rental property is cash flow positive, you can use the rental income to pay the taxes. However, because you should not use non-IRA money (i.e., savings) to cover IRA expenses, repairs, or costs incurred when the tenant moves out, be sure to run a reserve of several months before taking out funds to pay Uncle Sam.
The next item to consider early on when you invest in real estate in an offshore IRA is whether to convert to a ROTH. I will discuss ROTH conversions for offshore investors in more detail in a future article. For now, if you expect a return of 10-20% per year, and your income and tax bracket are low (maybe you recently retired), converting before buying real estate in an offshore IRA may pay off big. I understand it’s tough to pay taxes today for a potential savings in the future, but, if the upside is big in your market, you may take this tax gamble.
If you’ve held real estate in an offshore IRA for a few years, and it has maxed out on appreciation, then a ROTH conversion is unlikely to be beneficial. Now you need to consider longer term planning. For example, if you wish to live in the property 10 years from now, take a 1/10th distribution each year. This will allow you to manage the tax payments and possibly reduce your total tax paid by keeping you in a lower tax bracket throughout the decade.
To re-title 10% of the property, you must go into the recorder’s office and enter the change into the record. Hopefully, as in most U.S. states, you can make the transfer at zero value.
Remember that each of these distribution sis taxable in the U.S. and made at ordinary income rates. I assume you have reached an age where distributions may be made without a 10% penalty.
Another way to reduce your net tax when you distribute real estate in an offshore IRA is to cut out your high tax state. If you are considering moving offshore, or to a lower tax state, make the move 12 months before you take the distribution.
For example, if you are living in California, a distribution of real estate in an offshore IRA may be taxed at 10% or more. The same distribution to a tax resident of Belize or Panama should be at zero state tax . . .of course, federal tax still applies.
Finally, the Foreign Tax Credit may apply and provide a dollar for dollar credit for any tax you paid to the country where the property is located. Considering IRA distributions are taxed at ordinary rates, it’s unlikely the Foreign Tax Credit will totally eliminate U.S. tax, but it will ensure you don’t pay double.
I note that some countries charge transfer taxes and duties rather than a capital gains tax. Special attention should be paid to these, because they may not qualify for the credit but might be added to the property’s basis and therefore reduce your taxable profit.
If you are considering taking your IRA offshore, or would like to set up a specialized real estate investment structure, please contact us at firstname.lastname@example.org for a free and confidential consultation. We will be happy to work with you to structure your offshore IRA in a tax efficient manner.