You don't see debt-financed property often in an IRA. In fact, it has only recently come into the extreme mainstream of tax. You don't see it often as you have various requisites in place in order to consider the investment.
First off, the IRA has to be large enough to make the investment and keep reserves to fund losses. For example, if the property goes vacant, how are the mortgage and other costs going to get paid if I can only contribute $5,000 a year to the IRA? I need a lender willing to lend on a nonrecourse basis, which usually means that I have a lot of equity-to-value. Who will accept the investment, and who will prepare the necessary IRS tax returns to report the UBTI? UBTI is unrelated business taxable income that is due by an IRA on debt-financed property. UBTI applies to both an IRA and a Roth IRA.
If you want to roll over to a Roth IRA, the value of the property will be considered income, net of the mortgage. The law does not require you to have an appraisal as long as you have some reasonable basis for determining value at the time of the transfer. I think if you bought the property one year ago and you make some reasonable adjustment for the overall trend in your area for property values, you should be fine with the Internal Revenue Service. However, the IRA custodian will be reporting the Roth transfer, so you need to check with them on what they would want for reporting purposes.
Remember, in a Roth IRA your ability to contribute also depends on your adjusted gross income, or AGI. If you can't contribute, you have to be sure that the IRA has enough assets to sustain itself in the case of vacancy.
Ask the adviser
To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.