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The Difference an IRA Can Make

How does a real estate investment within an IRA compare to the same investment made with personal funds?

By: Ben Brazda

IRA Insights

“How does a real estate investment within an IRA compare to the same investment made with personal funds?”

I get this question quite often. It seems simple enough, but you might as well be asking “How many apples do I need to have a basket of oranges?” The comparison can be made; however, we have to level the playing field by first making apple juice from oranges.

A dollar in a traditional IRA is not the same as a dollar in the pocket. The dollar in your pocket has already been taxed, whereas, the cash in your IRA has not. Let’s set the stage:

You’re a pilot. You travel the world flying for a major airline. On one of your cross-Atlantic flights, you and your co-pilot, Floyd, start talking about investing. You discover that you both feel real estate is the way to go and soon realize that you are both in a very familiar situation and are actively saving money for just such an investment.

The Savings Begin

Both you and Floyd earn the same salary ($60,000) and put aside $5,000 each year for savings. You put your money into an IRA and he puts it into a brokerage account in his name.

By contributing to a traditional IRA you have $1,500 extra in your pocket while still putting aside $5,000 per year.

You each continue this pattern of saving for the next 20 years and your savings grow at 8% per year. To keep the comparison a fair one, you exercise amazing self restraint by not spending the extra $1,500 you have in your hand by investing it the same way.

Twenty Years Later

After 20 years, you have a total of $297,453 in savings and the co-pilot has $228,810.

Before this money can be used to buy real estate, the current investments need to be sold. For the non IRA investments, this will be a taxable event.

Non-IRA investments assume holding one stock to avoid yearly taxation.

After the tax is paid on your personal investment, your overall savings, including the IRA is $289,724, and your flying partner’s is $203,048. Although this may look like you are taking a commanding lead, keep in mind that your IRA has yet to pay its taxes that will be due upon distribution.

Buying an Investment Property

A few months pass, and once again you are paired up with Floyd, the co-pilot, on a flight to Mexico. You tell him about the investment property you found and ask him if he was able to find something too. He tells you about it, and to your surprise, it’s located in the same neighborhood as the one you are interested in buying with your IRA! When you get home, you finalize the deal through your IRA administrator. The deal was structured in a way that you personally own 21% of the property and the IRA owns the other 79%. Floyd of course, purchased the property outright with his savings. (Neither property is purchased with a loan.)

Rent and expenses are proportional to purchase price.

Holding the Investment

Both properties appreciate 3% per year and are generating income. Your property is producing a net cash flow of $1,690 per month while his pulls in $1,184 (this is because it’s a smaller house and keeps the comparison on equal terms). The income from the IRA portion of your property goes into the account tax deferred while your personal part, as well as the co-pilot income, will be taxable.

Five Years Later

It’s a while before you run into your friend again. In fact, 5 years pass and you are reacquainted when you both take a flight from L.A. to Tokyo. You immediately jump into comparing your investments and after 5 years your overall investment value is $419,873 compared to his $298,098

Rent income not earning interest.

By mid flight, you discover your co-pilot has listed his property for sale. He explains that he feels the real estate market in the area is at its peak and he wants out. Plus, he’s been thinking about retiring and feels that he has enough saved up to last him the rest of his life.

Selling the Investment

While in your hotel room that night, you realize that it’s probably time for you to also start thinking about retiring. Sleeping in a different city each night, along with the time away from your family, has worn you out. Living in a beach front property never sounded so good. When you get home, you have your IRA owned property listed for sale, and before long it’s put under contract and sold.

The proceeds from your sale get split between the IRA and yourself according to the ownership ratio. $265,253 went to your IRA tax-deferred and $66,904 went to your bank account after taxes. Floyd ended up with $223,013 after tax on his side.

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