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George Saenz, the Bankrate.com Tax Talk columnistOpening an IRA with rental income

Dear Tax Talk,
Can I open a Roth IRA if my only income is from rental property and interest? Is income from being a landlord considered earned income? I am looking for a way to put this money into a fund that does not pay taxes or need to be declared for the next three to five years.
-- Maddy

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Dear Maddy,
In order to set up an IRA, Roth or otherwise, you (or in the case of a married couple filing jointly, either spouse) must have taxable compensation, which is a more precise way of saying earned income. Compensation for purposes of an IRA includes wages, salaries, commissions, self-employment income, alimony and separate maintenance. It does not include earnings and profits from property, interest and dividend income, pension or annuity income, deferred compensation, income from certain partnerships or any amounts excluded from income (such as from Form 2555, relating to the foreign earned income exclusion).

Since rental income is not considered compensation for purposes of an IRA, you cannot make an IRA contribution. If you have sufficient rental activities and you're keen on contributing to an IRA, then you might want to consider setting up a management company that would employ you to manage the properties.

For example, you can set up an S corporation that receives a management fee from each property. Those fees are deducted on the rental property Schedule E and, in effect, wash with the income realized by the S corporation. The S corporation uses these fees to pay you a salary, which allows you to make your IRA contribution.

However, an IRA is really not an investment to make for three to five years. At a minimum, a Roth IRA needs to be around for five years in order to achieve the tax-free return you're looking for on growth within the account.

Bankrate.com's corrections policy -- Posted: Feb. 1, 2006
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