Rolling debt-financed property into Roth IRA

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Dear Tax Talk,
I own a rental property with a nonrecourse mortgage inside my individual retirement account. I want to roll the property over to a Roth IRA. Is the mortgage part of the taxable value, or do I only pay taxes on the value that is not mortgaged? Do I have to get an appraisal, or can I use the purchase price? I purchased it one year ago.
— Eve

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Dear Eve,
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.

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