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Roth Conversions??
Old 02-23-2005, 07:12 PM   #1
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Roth Conversions??

Is it worthwhile to begin an IRA to Roth conversion plan within the 15% bracket at age 59 to avoid the taxation of Social Security benefits in later years. The assumption would be that Social Security would begin at 62; married; and always remain in the 15% bracket even if the Social Security benefits were taxable. Seems like a wash to me, but maybe someone has some thought on this.
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Re: Roth Conversions??
Old 02-23-2005, 08:33 PM   #2
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Re: Roth Conversions??

I plan to do convert as much as I can while I still am within the 15% bracket before I sell my house which will definitely put me in 25% tax bracket.

MJ
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Re: Roth Conversions??
Old 02-23-2005, 09:27 PM   #3
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Re: Roth Conversions??

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I plan to do convert as much as I can while I still am within the 15% bracket before I sell my house which will definitely put me in 25% tax bracket.
How is selling your house going to put you in the 25% bracket?
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Re: Roth Conversions??
Old 02-24-2005, 05:06 AM   #4
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Re: Roth Conversions??

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How is selling your house going to put you in the 25% bracket?
Yeah, isnt there certain circumstances where you can sell your own house and not have to pay capital gains? I forgot the rules, but i thought there are some circumstances where that can apply.
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Re: Roth Conversions??
Old 02-24-2005, 06:13 AM   #5
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Re: Roth Conversions??

Quote:

Yeah, isnt there certain circumstances where you can sell your own house and not have to pay capital gains? *I forgot the rules, but i thought there are some circumstances where that can apply.
A married couple can exclude up to $500,000 of Cap. Gain on sale of primary residence. A single taxpayer. $250,000.
This can be done over and over again, and this particular change in the tax law, has now been in force long enough that the younger investors (In high appreciation areas), are using this as a wealth building tactic.
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Re: Roth Conversions??
Old 02-24-2005, 06:21 AM   #6
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Re: Roth Conversions??

Since I file single, I'm doing a series of mini Roth conversions every year until RMD (I'm 61). Even if stocks go nowhere the next 9 yrs - I still jump one tax bracket come RMD.

Scott Burns took a look at this a while back in the context of avoiding the 85% 'back door' tax on SS.

Fairly complex - you gots to run your own numbers for your own situation - make some assumptions - and place your bets.

Like - for instance Congress won't change the Roth rules - when the chickens come home to roost and they need the money.

P.S. I have no idea where cap gain/house exclusion fits in here - as to determining tax on SS income.
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Re: Roth Conversions??
Old 02-24-2005, 07:45 AM   #7
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Re: Roth Conversions??

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How is selling your house going to put you in the 25% bracket?
Sorry that I didn't clarify.

Since I own my 2 fam house free and clear, the $500k+ after expenses will earn me an additional $25K+ a year. Adding that to my existing investment income, will probably put me into the 25% tax rate.

Because, it is a 2 fam house and I am single, I can only take advantage of 1/2 of the $250k cap gain exclusion.

By the way, the cap gains on the sale of my house will be be offset by my unfortunate losses in the stock market (somewhat of a silver lining).

I assume I am not missing anything.

MJ


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Re: Roth Conversions??
Old 02-24-2005, 01:10 PM   #8
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Re: Roth Conversions??

Hmmm..I dont see anything in the tax code to limit your capital gains to half of the $250k because its a two family home.

Just to clarify...you own a building that is divided into two separate homes (eg an upstairs/downstairs, side by side or duplex arrangement), you live in it as your primary residence, etc...not that you own half and someone else owns the other half?

Can you steer me to the verbage that creates that limitation? I just re-read the IRS code on this and didnt see anything around it.

Also, you have a net GAIN of $500k in the sale...you are reducing by your purchase cost AND the cost of all improvements you've invested in the property (repairs, paint, roof, etc)? Wow.

If thats the case...go get married and take the full $500k. In fact, you can write up a movie script based on your experience running around with an engagement ring looking for a wife and sell it to paramount. Oh wait, its been done.... :P
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Re: Roth Conversions??
Old 02-24-2005, 04:48 PM   #9
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Re: Roth Conversions??

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Hmmm..I dont see anything in the tax code to limit your capital gains to half of the $250k because its a two family home.
I rechecked my records and I stand corrected. What I meant to say was that I can only use the $250k on the residendial 1/2 of the house. Since my capital gains on that 1/2 did not exceed $250k, I was unable to take advantage of a decent chunk of the $250k. Although I have heavy stock market loss to offset my cap gains, I may consider discontinuing the renting of the 2nd apartment for 2 years which as I understand it, would revert the house back to a 100% residential. Then I could make full use of the $250k exclusion. I have to review the rental income versus saved expenses (reduced heat, water), the freedom to travel for months and not being concerned about collecting the rent, as well as other landlord issues.

Of course, I could be lucky and the house could shoot get up another 30% by the time I sell it or it could drop 30% as well. Time will tell.

Quote:
you have a net GAIN of $500k in the sale...you are reducing by your purchase cost AND the cost of all improvements you've invested in the property (repairs, paint, roof, etc)?
I wish. The $500K+ is not my capital gains but what will be left after selling expenses but I get to keep it all because I own the house free and clear.
I did reduce my gains with all my improvement costs (new roof, new porch).
By the way, I thought I couldn't use ongoing maintenance expenses like repairs or painting to reduce my capital gains on my residential portion unless such expenses were needed to sell the house.

Any further comments will be appreciated.

MJ
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Re: Roth Conversions??
Old 02-24-2005, 06:31 PM   #10
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Re: Roth Conversions??

I'm still furrowing my brow.

I am completely unaware that renting out half of a two family causes you to have to take the 250k deduction on only half of the property...can you point to the tax code that refers to this? I cant find it!

In fact I read through a bunch of scenarios on selling multifamily dwellings involving renting part of it and aside from having to factor the depreciation back into the sale nothing was mentioned about having to restrict your capital gains exclusion to the part of the house you lived in.
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Re: Roth Conversions??
Old 02-24-2005, 06:36 PM   #11
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Re: Roth Conversions??

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I may consider discontinuing the renting of the 2nd apartment for 2 years which as I understand it, would revert the house back to a 100% residential. Then I could make full use of the $250k exclusion.
How is discontinuing the renting of the 2nd apartment going to make that apartment part of your primary residence?
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Re: Roth Conversions??
Old 02-24-2005, 06:53 PM   #12
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Re: Roth Conversions??

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I am completely unaware that renting out half of a two family causes you to have to take the 250k deduction on only half of the property...can you point to the tax code that refers to this? *I cant find it!

In fact I read through a bunch of scenarios on selling multifamily dwellings involving renting part of it and aside from having to factor the depreciation back into the sale nothing was mentioned about having to restrict your capital gains exclusion to the part of the house you lived in. *
Doesn't IRC Section 121 clearly explain the exclusion applies only to your PRIMARY residence?
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Re: Roth Conversions??
Old 02-24-2005, 08:29 PM   #13
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Re: Roth Conversions??

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How is discontinuing the renting of the 2nd apartment going to make that apartment part of your primary residence?
My house is in a neighborhood of many single family houses similar to mine with some having been converted into 2 family houses. You really can't tell that it is a 2 fam house It has one front entrance. I could start using the 2nd apartment for personal use like having guests or my father stay over for extended visits. I have read IRS pub but I will need to research this further to make sure that I wouldn't have any problems with the IRS.

MJ
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Re: Roth Conversions??
Old 02-24-2005, 08:48 PM   #14
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Re: Roth Conversions??

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I'm still furrowing my brow.
I am completely unaware that renting out half of a two family causes you to have to take the 250k deduction on only half of the property...can you point to the tax code that refers to this? I cant find it!

In fact I read through a bunch of scenarios on selling multifamily dwellings involving renting part of it and aside from having to factor the depreciation back into the sale nothing was mentioned about having to restrict your capital gains exclusion to the part of the house you lived in.
TH,

I hope you are right cause I would love to be wrong on this, but I thought the $250k per adult exclusion was limited to your primary residence.

For example, if a 2 fam house had a capital gain of $300k, I thought the $250k exclusion would eliminate the 1/2 of the capital gain ($150k) against the residential portion leaving the $100k exclusion unused and lost. The owner would have to pay taxes on the other 1/2 of the capital gain ($150k) plus the accumulated depreciation.

Any accountants out there with some facts.

MJ
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Old 02-25-2005, 07:10 AM   #15
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If it sounds too good to be true...

MJ, I'd recommend you post the real estate question at Vanguard's <a href="http://socialize.morningstar.com/New...277">Investing DURING Retirement</a> board. There are several CPAs over there and many posters, including BruceM, with real estate experience. (I'll warn you in advance to ignore "Avilynn", an 80ish curmudgeon who tends to be even more opinionated & combative than me.)

You could also try BruceM and the other CPAs at Ed Slott's <a href="http://www.irahelp.com/cgi-bin/forum/index.cgi/">IRA discussion</a> board. One of them writes for Investopedia. The professional answers seem to come mostly from Mary Kay Foss, Bruce Steiner, and Denise Appleby.

Having directed you (hopefully) to the RIGHT answers, here's what I think. IRS rulings have determined that although home offices can be tax-deductible their deduction is also subject to recapture upon the sale of the house. I think that you're in a similar situation with your rental. While you may own title to the entire property, the rental portion is not entitled to the cap gains exclusion. In fact, if you've depreciated it on Schedule E, you'll have to pay recapture tax on the depreciation. Even worse, the new roof (and other repairs affecting both the owned and the rented parts of the property) should have been apportioned between the two categories as well. Part of the cost of the new roof raises your homeowner's basis while the other part applies to the rental property's depreciation. But it all depends on how well you can document what you were renting out when you were making repairs or improvements.

Having said that, I think you're still eligible for the full amount of your cap gains deduction. If your deduction is $250K, then that full deduction would apply to the portion of the residence's sale price that was your primary residence. So when you sell the house, you'd deduct $250K from the gains on the portion of the house that was your primary residence.

Another approach would be to boot out the tenants, avoid renting for two years to claim that the entire house is your primary residence, and then sell. Unfortunately any rental-property depreciation would still be subject to recapture.

In today's market perhaps you'd be ahead by selling now, even after you pay a pitbull CPA to sort out the situation.

TH, I'll let one of the above-mentioned CPAs point you to the tax code or the PLRs.

Back to StevelB's question: The answer is yes. Initially a conversion may seem like a wash, but it also allows you to defer income instead of stuffing RMDs down your throat (which may bump you into a higher tax bracket, in addition to taxing your SS). Deferring the income gives it more time to compound tax-free to be withdrawn as you deem fit instead of IAW the IRS' tables. You'll have to decide whether you do the conversion all at once or whether you defer SS while you accomplish the conversion over several years. (SS deferral is a complicated individualized decision that's been beaten to death here on several other threads.)

One additional benefit that BruceM points out-- when the conversion tax is paid with funds outside the IRA, the net effect is a contribution boost to the new Roth by the amount of the tax. IOW all of the converted IRA is now compounding tax-free, not just the after-tax portion of the conversion. Some calculators point out this difference, many do not.
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Re: If it sounds too good to be true...
Old 02-25-2005, 08:07 AM   #16
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Re: If it sounds too good to be true...

Quote:
Having directed you (hopefully) to the RIGHT answers, here's what I think. IRS rulings have determined that although home offices can be tax-deductible their deduction is also subject to recapture upon the sale of the house. I think that you're in a similar situation with your rental. While you may own title to the entire property, the rental portion is not entitled to the cap gains exclusion. In fact, if you've depreciated it on Schedule E, you'll have to pay recapture tax on the depreciation. Even worse, the new roof (and other repairs affecting both the owned and the rented parts of the property) should have been apportioned between the two categories as well. Part of the cost of the new roof raises your homeowner's basis while the other part applies to the rental property's depreciation. But it all depends on how well you can document what you were renting out when you were making repairs or improvements.

Having said that, I think you're still eligible for the full amount of your cap gains deduction. If your deduction is $250K, then that full deduction would apply to the portion of the residence's sale price that was your primary residence. So when you sell the house, you'd deduct $250K from the gains on the portion of the house that was your primary residence.
Thanks Nords. This is what I had understood. Since my cap gains on my residential portion will be much less than $250k, I will not be able to take full advantage of the $250k exclusion :'( unless I can reclaim the other rental 1/2 of the house for myself. I will crunch the numbers to see if it is worth it.

MJ :-/
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Re: Roth Conversions??
Old 02-25-2005, 11:59 AM   #17
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Re: Roth Conversions??

Ick, I found it...publication 523 buried down near the bottom. I presumed since the primary residence and the rental were part of a single unit, part of which was the owners main residence that they'd both be part of the exclusion but thats specifically called out. I know my dad did it but he had lived for 2 years in each of the two sides of the 2 family within a 5 year period. Now I know why he moved from one side to the other...

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Re: Roth Conversions??
Old 02-25-2005, 06:44 PM   #18
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Re: Roth Conversions??

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Is it worthwhile to begin an IRA to Roth conversion plan within the 15% bracket at age 59 to avoid the taxation of Social Security benefits in later years. *The assumption would be that Social Security would begin at 62; married; and always remain in the 15% bracket even if the Social Security benefits were taxable. *Seems like a wash to me, but maybe someone has some thought on this.
I think you have to look at for more than just the tax impact. For one, the Roth IRA can be passed to the next generation and they will be able to base their RMDs on their life expectancy. And, those RMDs will be tax free. Also, with a Roth, you do not have to take RMDs unless you want to.

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Re: Roth Conversions??
Old 02-28-2005, 05:46 PM   #19
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Re: Roth Conversions??

Quote:

Sorry that I didn't clarify.

Since I own my 2 fam house free and clear, the $500k+ after expenses will earn me an additional $25K+ a year. Adding that to my existing investment income, will probably put me into the 25% tax rate.


MJ

MJ,
I know you weren't looking for tax advice, but I couldn't resist hopping on my soapbox -- Unless you put that money into a taxable Penfed CD, there is no reason to think that 500k of cash has to generate 25k of new taxable income. Lots of ways to put the 500k to work earning returns even higher than 5% but which are deferred, possibly forever, keeping your actual taxes paid to a minimum. (You might need to pay on capgains disrtibutions, or dividends if the money were in an equity fund, for instance).

Don't know your asset allocation tastes, but as I have said elsewhere, I think ERs, unless they are mega-zillionaires, should be able to keep themselves in the lowest brackets, basically by raising capital through selling appreciated assets at low long-term capital gains tax rates.

Put a nice umbrella over the taxable earnings you do have by using all your deductions (including health insurance premiums now). Don't over-do the fixed income portion of your portfolio, buy tax-managed and index funds, rebalance only once a year, maybe have a self-employment sideline which generates some legitimate expenses against a bonafide effort to produce a bit of part-time income.

And you didn't mention: aren't you going to need to roll some of that money into a new residence?
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