Author Topic: Inherited IRA and house renovation: tax advice needed!  (Read 1557 times)

ehertzman

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Inherited IRA and house renovation: tax advice needed!
« on: January 03, 2017, 08:40:44 AM »
Hi, all--
I'm a first-time poster, so your tips on posting success are very welcome.

I've been FI for four years, and set to pay off my house in 15 months. Currently, the amount of money I take from my investments allows me to pay no taxes. Recently, I inherited an IRA, which has all sorts of rules that I have researched. My question is, I want to use the money I've inherited for some rather major house renovations. However, simply cashing it out is not smart, since I would end up paying about 1/3 of it in tax. It looks as though I could sell some of my own investments up to $38K, and pay no capital gains tax on it. Would it then be smartest to take the rest of what I will need in a HELOC? A refi? (Though I hate to accrue another 15 years of debt!) Another option I haven't thought of? How would you proceed? Thanks in advance for any help you can offer.

Spork

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #1 on: January 03, 2017, 09:19:44 AM »
Warnings/caveats first:  I'm not a tax expert.  I'm not a financial advisor.  I'm an internet stranger and logic says don't take long term financial advice from me!

Now:  I'm somewhat in the same boat.  I recently inherited an IRA of fairly significant size.  Before I inherited it, I was already FIRE and had a fairly standard plan of building a Roth IRA ladder by doing yearly conversions of tIRA -> rIRA.  Clearly the iIRA with RMDs breaks that plan.  You have additional required income and I had to start planning again from scratch.  tIRA to rIRA conversions would have to either go away entirely or be significantly less.

Upon getting the iIRA, I started running numbers looking forward into my future.  I built a little spreadsheet where I calculated my RMDs for the iIRA.  And since I probably wouldn't be converting my entire tIRA to Roth... I added in RMDs for the expected balance of the tIRA when I hit 70.5.  I urge you to do this exercise and see where you stand.  In my case: Holy crap.  As you start to get older, the formula for RMD continually lowers the divisor and the RMD starts to exponentially rise.  At some point, I was going to be making many times more than my expenses (and 2-4 times the highest salary I'd historically ever received).

Because of the above... I've pretty much opted to try to draw down the inherited IRA first.  2017 will be my first year of RMDs, but my personal plan is to take the minimum PLUS some amount that will put me right at about 390% of the FPL for Obamacare subsidies.  (This is after including investment income.)  I believe there is also a good case for taking a distribution of an amount that lands your income just below the tax level for 0% capgains/dividends ($75,300 for married).  This gives you the lowest effective rate.

All that to say:  Run the numbers.  There is a good chance that taking a higher than required minimum distribution on your inherited IRA may be beneficial to you in the long run.  If you are debt averse and don't want to take out a mortgage, this may be a reasonable way to go.  I'm not saying cash it out entirely... but if the amount is significant, you might take enough cash to take you to the top of the current (or next level up) tax bracket.

To be fair, I'll also mention that a loan that is less than the rate you'd get investing is probably a reasonable way to go.  (But I have a paid off house, and I personally wouldn't re-mortgage it to invest.  Others would.)

Catbert

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #2 on: January 03, 2017, 12:02:30 PM »
As Spork discussed this issue is potentially bigger that the impact on one tax year.  Think about that before you decide.

When you say you could take 38K from investments w/o tax implications does that mean you have 38K left in your 15% tax bracket?  Or that a 38k total sale would yield a much smaller capital gain which would fix in your 15% bracket?  Regardless, I would definitely fill up your 15% bracket either with 0% capital gains or with *income* from iIRA.  Use that as part of your house reno budget.  Could you divert the extra house payments you're making to complete the reno budget?  Yes, that would kick out your payoff date, however, you would encounter the expense/hassle of more iIRA distributions, capital gains tax or HELOC/refi costs.


Spork

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #3 on: January 03, 2017, 12:19:51 PM »
As Spork discussed this issue is potentially bigger that the impact on one tax year.  Think about that before you decide.

When you say you could take 38K from investments w/o tax implications does that mean you have 38K left in your 15% tax bracket?  Or that a 38k total sale would yield a much smaller capital gain which would fix in your 15% bracket?  Regardless, I would definitely fill up your 15% bracket either with 0% capital gains or with *income* from iIRA.  Use that as part of your house reno budget.  Could you divert the extra house payments you're making to complete the reno budget?  Yes, that would kick out your payoff date, however, you would encounter the expense/hassle of more iIRA distributions, capital gains tax or HELOC/refi costs.

I think this is good advice UNLESS ... you're counting on ACA subsidies.  If you're counting on ACA subsidies... this will end them.  I know ACA is potentially on the chopping block with the new administration, but I am not planning on making any guesses on what is next.  I'd rather plan on what we have now and be prepared to shift.

You may very well have a good argument to just drop the subsidies altogether and take pay the tax + full unsibsidized insurance cost.  If so, I'm all ears.

Catbert

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #4 on: January 03, 2017, 01:49:59 PM »
You're absolutely right Spork.  I forget about ACA subsidies.  Lots of moving pieces for what OP thought was a simple question.

ehertzman

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #5 on: January 04, 2017, 09:43:48 AM »
Yikes--yes, more moving pieces than I had thought. Hmmm. Probably time for some professional advice. Thank you all for your thoughts.

Spork

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Re: Inherited IRA and house renovation: tax advice needed!
« Reply #6 on: January 04, 2017, 10:10:10 AM »
Yikes--yes, more moving pieces than I had thought. Hmmm. Probably time for some professional advice. Thank you all for your thoughts.

I will certainly not tell you not to get professional advice.  It's probably a good plan.  But I think it's still a good idea to understand how they work and run the numbers yourself.  If nothing else, it will help you have an intelligent conversation with the attorney/accountant/professional you hire.  And as always, be prepared for your plan to change.  As political climates shift, you've got a near 100% chance things will change and turn your plan upside down.

I don't know if it helps, but here's the thread where I tried to understand/come to grips with inherited IRAs:  http://forum.mrmoneymustache.com/taxes/rmd's/
I made up a fictional example and tried to read through the IRS site/blogs/etc and understand how the gears really work.  I think I got most of it right, based on the feedback.