Ways To Take Money From Your IRA Tax-Free!
Many investors are not aware of all the different ways that one can take money out of one's IRA income tax-free. While there are many ways to take money out of an IRA before age 59 ½ without paying the additional 10% tax, we will be focusing on regular distributions made by those over 59 ½.
Whatever you do, please make sure you do a tax projection and determine what your income tax bracket will be. And, when employing these methods, bring your taxable income back up to zero so that you are not missing out any part of the deduction! Remember - the income tax on zero taxable income is zero and the income tax on negative taxable income is also zero!
In the event that you do not need the money from your IRA, it is still usually best to convert part or all of the existing IRA into a Roth IRA, at least up to the point where there is zero taxable income or often up to the top of the 15 percent tax bracket. By converting it to a Roth, you will be able to take money out of your IRA income tax-free in the future as well.
Let us now look at some of the possibilities. There are many other ways that one can utilize and new tax laws and private letter rulings are being changed as you read this…
• Capital losses.
Many investors have unrealized capital losses, especially due to the recent stock market correction. Determine the basis of each of your investments and determine whether you have any unrealized capital losses. Remember that, usually, only $3,000 of net capital losses can be taken on an income tax return. However, the additional capital losses can be carried forward to future years. This $3,000 loss can offset a $3,000 distribution from an IRA, making the distribution from the IRA income tax-free.
• Charitable contributions.
If you are charity-minded, it may be smart either to make an additional contribution to a non-profit organization, which is usually tax-deductible, or even to establish a charitable remainder trust. These charitable contributions can be used to offset the IRA distribution. Remember that itemized deductions are reduced depending on your adjusted gross income.
• Net operating losses.
Many individuals have deductions or losses in a prior year that generated a negative taxable income. Many of these deductions from the prior year are able to be carried forward into the next year and can be taken against the IRA distribution.
• Losses relating to the sale of rental properties.
Many people forget that the loss on a rental property usually will generate an ordinary loss and not a capital loss. A net capital loss, as described above, is usually limited to only $3,000. An ordinary loss, on the other hand, usually has no limitations and therefore this loss can be utilized 100 percent!
Note: be sure to properly calculate the correct basis in any piece of property, especially real estate, after someone has passed away. There is usually a step-up in basis for part or all of the property after someone passes away.
Let me give you an example.
Let us assume that a married couple bought a rental property in California 20 years ago. Let us assume that they paid $300,000 for the property and took depreciation of $250,000. The adjusted basis is currently only $50,000. Let us also assume that the property is now worth $1,000,000. If they sold the property today, there would be a $950,000 capital gain.
However, if either of the individuals passed away, normally, there would be a step-up in basis on the entire amount because the property is in a community property state. In this case, the basis is now stepped-up to $1,000,000.
Let us assume that, a year later, the surviving spouse wanted to sell the property, and the fair market value dropped to $900,000. If the surviving spouse sold the property for the lower amount, the difference of $100,000 would be tax-deductible as an ordinary loss all in one year!
The step-up in basis rules present a number of fantastic opportunities including:
• Many tax preparers do not recalculate the step-up in basis properly. For example, if we look at the example above, the surviving spouse could re-depreciate the property all over again using the current fair market value. The depreciation expense would be significant and this also could be utilized as a deduction against IRA distributions.
• If you are tired of managing your real estate, you could sell the property without paying any capital gains tax (assuming that it has not gone up in value after the person passed away). If you are in a situation where you are facing significant capital gains on selling your rental property, you could invest in a tenant in common property if you met the requirements of a 1031 exchange when selling your rental property.
• Income tax credits.
There are various investments that will generate a tax credit. Many investors are not familiar with the difference between a tax credit versus a tax deduction. For example, if a taxpayer gave $3,000 away to a charity, this an income tax deduction and would save most taxpayers approximately $1,000 in tax. On the other hand, a tax credit reduces your taxes dollar for dollar. In the event that there were $3,000 in tax credits, the client would reduce their income taxes by $3,000. Therefore, tax credits are usually much more valuable than tax deductions. Many investments will generate a tax credit. When investing, make sure that the overall investment return from the tax credit generator is a good one. Don't just invest based on tax credit benefits. It is imperative that you always review the overall investment return carefully.
• Oil and gas investments.
Many people forget that most investments in an oil and gas investment generate an ordinary loss, which also can be utilized to offset distributions from an IRA.
There are many other ways to generate losses, such as ordinary losses on businesses, S Corporations, etc. Also, rental property will usually generate a loss, depending on the circumstances.
There are also other deductions that can reduce taxable income that is generated by an IRA distribution. This could include interest expense on a mortgage, prepaying the state income tax during the year, and other types of deductions as well. Whatever you do, please remember to prepare an income tax calculation and remember to include the computation for alternative minimum tax. In addition to this, remember that the income tax laws are changing constantly, which could alter these suggestions and also will offer many new alternatives that are not even available today.
Remember - the only thing constant is change – especially when it comes to tax laws. Have a question about your tax planning? Call us at 510-235-1044 to go over ways we can reduce your tax bill.
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