How Does Your ROTH IRA Relate to a Cost Segregation Study?

Was a cost segregation study or energy study ruled out due to a net operating loss at the personal tax level of the shareholder/partner? Depending on the size of the client’s Individual Retirement Account (IRA) proposing a potential ROTH IRA conversion of their IRAs could provide not only significant income tax planning opportunities, but also can provide an avenue for a study to be viable.

Many people say they would rather not think about taking a hard look at investment strategies for retirement. However, with the legislation that came into effect back in 2010, along with possibilities of tax rates increasing in the near future, taxpayers can make some smart choices now that can really pay off at retirement age.

Gross Income Limitation Removed

Prior to 2010, individuals can only convert a traditional IRA to a Roth IRA if their modified adjusted gross income is $100,000 or less. For 2010 and forward, taxpayers can convert their traditional IRAs (and funds from certain other eligible retirement plans) to a Roth IRA with no gross income limitation. Therefore, no matter what the income level of the individual was, the Roth IRA conversion is available. The new legislation also removed the requirement for married couples to file jointly to be able to make this conversion.

Traditional IRA vs. Roth IRA

Most people are familiar with IRAs. Some are even aware that there are two kinds of IRAs: traditional IRAs and Roth IRAs. In a traditional IRA, participants can contribute $5,500 per year $6,500. if age 50 or older). Whether or not the contribution is deductible depends upon the adjusted gross income of the taxpayer(s). If you are allowed to deduct the contribution, then any distributions – including your original contributions plus earnings – are taxable. If you are not allowed to deduct contributions, then only the earnings portion of any distribution is taxable.

In a Roth IRA, contributions are not deductible. However, all distributions – whether from original contributions or earnings – are not taxable. Therefore, taxpayers who convert a traditional IRA to a Roth IRA will not need to pay tax when the Roth IRA distributions are made. Also, a Roth IRA has no minimum distribution requirement when the account holder turns 70 1/2, as does a traditional IRA.

Tax Considerations

The initial conversion does have tax effects. An IRA conversion is treated as a taxable distribution, taxed as ordinary income at your marginal tax rate. Although this accelerates the taxable income that you would eventually pay on distributions from a traditional IRA, the future appreciation in the account grows tax-free.

For 2018, conversions can be made, but the tax will be due with the tax return filed for the year of conversion. Keep in mind that after the tax on the conversion is paid, all of the growth in the account can be distributed tax-free after the taxpayer reaches age 59 1/2. (Please note that there is also a five-year holding period that must be reached before tax-free distributions of earnings can be made.)

How does this relate to Cost Segregation Studies?

If you have a large IRA that can be converted to a ROTH, the deductions that a cost segregation study or energy study would provide, excess deductions can be used to offset the income earned on the ROTH conversion.

For example, if you have a personal net operating loss of $500,000 and an IRA of $700,000 the whole account could be converted and $200,000 additionally would be offset from the excess deductions provided by a cost segregation study or energy study.

For more information, please contact Engineered Tax Services by dialing (800) 236-6519.

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