Ask the IRA Expert: How do the Roth IRA Rules Apply to Investments?

By John Bowens2 Comments
Question:

I am over 59 1/2 and purchased a property using my Roth IRA.  How long do I have to wait to sell it?  I heard five years?  

Also, for example, if I paid $125k using my Roth IRA and if I were to sell for $250, would I pay tax on the difference of $125k?  

Also, the last question; when I do improvements, are they added to the original purchase price - so that I don't have to pay tax on the improved amount?  

Thanks.
 -Karen N.
 
Answer:

Karen,

It is true the Roth IRA has the 5-year rule and you use post-tax dollars to fund contributions.  These aspects, along with the lack of the Required Minimum Distribution (RMD) at age 70½, no yearly tax-deductions, and certain eligibility requirements, are distinctive to the Roth IRA when compared to a Traditional IRA.

 Let’s take a look at the Roth’s 5-year rule first.

The 5-year waiting period applies to taking personal distributions.  The IRS rules for a Roth allow you to take your contributions out of the account tax and penalty free once your account has been open for 5 years at any time– even if you’re under age 59 ½.  This detail can be beneficial if you’re trying to have an emergency fund and save for retirement. 

That said, you must be absolutely certain you are only taking out the contributions.  Taking out the earnings or growth without meeting the requirements could be seen as a premature distribution and come with taxes and penalties.  You might find it beneficial to seek the guidance of a tax professional to navigate this process.

When it comes to your investments, any growth, gains, earnings, or profits are tax-free.  To use your example, if you sold the investment property in Roth and made a profit of $125K, that gain would go back into your account.  The same would apply if you chose to rent the property and received a monthly rental income deposit.   As mentioned above, if you were to take a personal distribution of those earnings without meeting the 5-year rule and being under 59 ½ then it could be seen as a premature distribution.  This detail would be true whether you invest in traditional or alternative investments.

Just as all income and profit must go back to the account; all expenses must be paid from the account.  Whether you are doing renovations, repairs, paying for property taxes, or any other expense the property needs, it needs to be paid from your Roth IRA.  Since these payments maintain the investment, they are not seen as personal distributions.  Going back to your example, if you make improvements to your investment property and increase its value; it is still seen as growing the investment.  
  
Keep in mind - you may find it in your best interest to review your financial and investment plans with a qualified advisor so you know you’re on the right side of the IRS if you ever are concerned.

John Bowens
National Education Specialist
Equity Trust Company
 
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