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Merlo
Merlo, Accountant
Category: Tax
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Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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I am retired with an IRA (over 60 years old). I want to buy

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I am retired with an IRA (over 60 years old). I want to buy a house for $200K for my primary residence. I have a house to sell which will probably bring $150K It is currently my primary residence. How can I minimize my tax hit?

If I withdraw cash from IRA I will have steep taxes. Then when I sell my other home I will have steep taxes on the profit. How can I minimize my tax bill?
Submitted: 5 years ago.
Category: Tax
Expert:  Merlo replied 5 years ago.
Hello Randy,

Can you please tell me how long you have owned your current primary residence and how long you have lived there?

Customer: replied 5 years ago.
I have owned my current home for about 20 years. It is paid off.
Expert:  Merlo replied 5 years ago.
Hello again Randy,

Under current IRS regulations, when you sell your primary residence, you are allowed to exclude $250,000 from any gain you have (or $500,000 if you are married filing a joint return) before any excess gain is taxable.

In order to be considered your primary residence, you must have owned the home for at least 2 years and you must have lived in the home for at least 2 of the last 5 years preceeding the sale. You qualify on both points. So when you sell your current home, if the market value is $150,000, by the time you claim your allowed exclusion, you will have no taxable gain.

Regarding your IRA account, if you do decide to withdraw some funds from that account to help pay for your new home, any amount you withdraw will be subject to ordinary income tax. The actual amount of tax that you will end up owing will depend on your total income for the year, including the IRA withdrawals you made, as it is your overall income that determines the tax bracket you are in.

But you will not owe any tax on the sale of your current home.

If this was helpful please press the Accept button. Positive feedback is also greatly appreciated.

Thank you Randy, and let me know if you have additional questions.

Customer: replied 5 years ago.

So what else can I do? Five year income average? Buy from inside the IRA? Buy the new home as an investment?

 

So far you have suggested nothing to reduce my tax bill, therefore I am not yet satisfied.

Expert:  Merlo replied 5 years ago.
Hello again Randy,

Before trying to answer your question, could you please provide a little additional information.

You said you are currently retired.

1. Are you married or single?

2. Do you and/or your spouse receive SS benefits? If so, how much do each of you receive each year?

3. Do you and/or your spouse have any other income for the year such as retirement plan income or income from investments? If so, how much total do you have each year from the other income sources?

Having this information will help me better understand your current tax situation.

Customer: replied 5 years ago.
I am Married. I recieve about $35K in retirement income from my employer and Social Security. No other income.
Expert:  Merlo replied 5 years ago.
Hello again Randy,

Is the $35,000 that you receive strictly from your employer?

How much do you receive from SS?

The reason I ask this is so that I can determine how much, if any, of your SS benefits are taxable.

Customer: replied 5 years ago.

I am not home right now so I can't tell you exactly but I think about $24K is social securtity, the rest is from my employer.

Expert:  Merlo replied 5 years ago.
Hello again Randy,

Thank you for the additional information.

I want to try and explain some things in my response, so allow me about 10 or 15 minutes to get this typed up and then I will post a reply back to you.

Expert:  Merlo replied 5 years ago.
Hello again Randy,

First, I would like to address some of the things you brought up as possibilities:

1. 5 year income averaging - this was disallowed a number of years ago by the IRS and is no longer an option execpt for people in the farming and fishing trades.

2. Buying your home inside of the IRA - this is not an option for an IRA investment.

3. Buying the home as an investment - this still does not reduce or eliminate any tax that you owe on your IRA withdrawals.

We have already established the fact that you will owe no tax on the sale of your current residence. So all the sales proceeds that you receive from your current home can be used towards the new residence you wish to purchase. Since you would like to use the funds from your IRA account to do this, the question becomes how to minimize tax on those withdrawals.

The one basic thing that you must understand about IRA withdrawals, is that there really is no way to minimize tax on the withdrawals, other than to keep the withdrawals down to an amount each year where it keeps you in a lower income tax bracket. When you withdraw funds from your IRA account, those funds become taxable, regardless of what type of investment you use them for, so there is no other option for reducing your taxes on the withdrawals, other than to keep down the amount you withdraw each year, to a point where it keeps you in a low bracket.

In your current situation, you said you receive about $24,000 in SS benefits and another $11,000 from your employer's retirement plan. This would mean that none of your SS benefits are taxable at this point.

When you receive SS benefits, if that is your only source of income, then the benefits are not taxable. However, if you receive other income, including IRA withdrawals you make in a year, then part of your SS benefits may also be taxable, if your other income exceeds the allowed amount.

There is a formula which is used to determine if any of your SS benefits are subject to tax and here is how that works. As a married person, SS allows you a base amount of $32,000. You must then take half of what you receive in annual SS benefits and subtract that from the base amount. The result is what you are allowed to have in other income before any of your SS benefits are subject to tax. Since your SS benefits are currently around $24,000, then if we take half of that ($12,000) and subtract it from your base of $32,000, that means you could have an additional $20,000 in income each year without any of your SS benefits being taxable.

Right now you are receiving an extra $11,000 from your retirement plan. That means you could have another $9,000 in annual income without any of your SS benefits being subject to tax. That being the case, here is what I would suggest that you do.

If you sell your current home for $150,000 and purchase another home for $200,000, then take out a 5 year balloon note to finance the other $50,000 you will owe on the new home.

Each year, withdraw $9,000 from your IRA account. This is the amount you can still have in income without subjecting any of your SS benefits to tax. This would then give you total taxable income for the year of $11,000 from your retirement plan and $9,000 from your IRA, for a total of $20,000. Since you are married you are allowed a standard deduction of $11,900 plus exemptions for you and your wife of $3,6,50 each. That gives you total deductions of $19,200 against your $20,000 income. That would then only leave you with taxable income for the year of $800, and your tax on that amount would be $80.

If you take out the $9,000 each year for the next 5 years, then at the end of the 5 year period, you will only owe another $5,000 on the home, and can pay off the balance in the 6th year. Each year that you do this you will owe no more in tax than $80.

The interest rate that you would be paying on the 5 year balloon note should be no more than around 5.5% to 6%, and of course your principal amount will be reduced each year as you make annual payments of $9,000 on the note.

This is going to be the best way for you to minimize taxes on your IRA withdrawals.

There is one other thing that I would suggest. If you choose to go this route, then at the end of the 5 years, once your new home is paid for, I would continue to take yearly withdrawals from your IRA account of $9,000 each year, since it will only cost you tax of $80 to do this. Then take that $9,000 and roll it over in to a Roth IRA account instead of a traditional IRA.

Once you have the Roth IRA open, you never have to worry again about paying tax on that Roth IRA account. Any earnings that are made are totally tax free. So in future years when you make Roth IRA withdrawals, you owe no tax whatsoever. So your money still continues to grow tax free, and the money it earns is also free from tax. And you should definitely take advantage of making those $9,000 annual withdrawals since by doing so your tax bill is only $80 on the entire amount.

If this was helpful please press the Accept button. Positive feedback is also appreciated.

Thank you again Randy, and let me know if you have more questions. I am happy to help you with whatever I can.

Merlo, Accountant
Category: Tax
Satisfied Customers: 9783
Experience: 25+ years tax consulting. Specializing in returns for US citizens living abroad
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