Author Topic: Cashing out a $1M IRA early to buy an Airbnb?  (Read 4095 times)

Nochka

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Cashing out a $1M IRA early to buy an Airbnb?
« on: June 29, 2019, 01:50:51 PM »
Iím a 48-year-old who was pushed out of a corporate job recently, and finds myself really enjoying being a stay-at-home dad for my adolescent kids. During my time-off, I've been scratching my head about how to avoid returning to work, and have a plan that's so crazy it just might work. Or it just might cause irreparable long-term financial damage.

We own two homes, so my first step was to put one on Airbnb, and we're on track to generate $100K/yr from an $800K house. However since the house has a large mortgage, our profits are fairly modest. (When I include the appreciation of the home ó about $75K last year ó theyíre much better.)

It occurs to me that with a second property like it ó and no mortgage ó I would have enough net income never to work again. In theory I could pay cash for that second, similar house through a combination of my savings ($250K) and ó now the crazy part ó cashing out my regular IRA ($1.1M). I would pay about 40% in tax and 10% in penalties on the IRA withdrawal, so Iíd be left with around $550K, plus the $250K = $800K.

I did a simple spreadsheet to compare the the expected growth of my IRA to the rental income and appreciation of the property over the next 20 years, and the numbers seem like a push. The expected rental income plus appreciation is equal the expected growth of my IRA and cash savings. Obviously since Iím spending the rental income I will have a lower net worth in 20 years, but maximizing my net worth is not the point of retiring early.

A couple other data points: my wife has a job that she loves and no interest in retiring soon, so we wouldnít be entirely dependent on Airbnb for income. We also have college savings that could serve as an emergency reserve. At some point ó we hope not for a long time, but likely within 15 years ó she will inherit a family trust that is larger than my IRA. Finally, over the last 6 months Iíve found that I really love managing the Airbnb. I was worried about dealing with guests, but I find them preferable to bosses because the bad ones are usually gone in 3 days.

I donít like the idea of depleting our savings, however after doing so I would have about $1.4M in real estate equity ($800K house plus $600K equity in our other houses), and presumably could refinance or sell down the road if we needed money for college, etc.

Two questions: 1) Is this idiotic (esp. the IRA withdrawal)? and 2) If it's not idiotic, is there a better way to finance? (With me not working, mortgages on both houses, and only 6 months of rental-income history, borrowing is out of the question for now.)

Iíve looked at setting up 72t withdrawals as an alternative to an Airbnb, but the income would be lower by half initially ó probably more over time as the rental income grows ó which is not enough to cover our expected expenses. Iíve also thought about other businesses that require less capital, but they would require much more work, and seem more speculative than replicating an existing, successful model.

Any hole-poking and other insights from the folks here would be greatly appreciated, as you've all thought longer and more deeply about these things. Thank you!

lhamo

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #1 on: June 29, 2019, 03:10:28 PM »
Why on earth would you even contemplate this -- losing 40% of your retirement savings to taxes is INSANE!!!!!

What (if any) is the shortfall between your wife's earnings + the existing rental income and your current spending?  It would be smarter to figure out how to close that gap by reductions in spending (you can bring down your expenses a LOT by doing more stuff in-house as the SAH spouse) plus PT or occasional work, rather than cashing out long-term investments.  You can use any excess to pay down the mortgages to improve cash flow.  I would have the discussion with your partner about a time-frame for experimenting with this as an alternative to going back to FT work -- this will obviously depend on how much of a cash stash you have in addition to the retirement accounts, but something like 2-3 years to see how it goes might be reasonable, with the understanding that if your net worth is growing it makes sense for you to continue to SAH and develop the rental income stream, especially since you likely have a large inheritance coming down the road that will mean your current retirement savings provides more than enough for the future.

Also, you should start researching places like Bigger Pockets and Paula Pant's stuff to learn more about the fundementals of rental investments.  Since you have the current property it might be worth hanging on to since you enjoy air bnbing and you would lose a lot in transaction costs by selling it, but it isn't a great return on capital.   

RWD

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #2 on: June 29, 2019, 03:44:19 PM »
We own two homes, so my first step was to put one on Airbnb, and we're on track to generate $100K/yr from an $800K house.
Is that gross or net after expenses?

Yes, cashing out the IRA and taking the tax hit is a terrible idea.

erutio

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #3 on: June 29, 2019, 04:11:41 PM »
Regarding the income from the airbnb, you cant count appreciation as part of your "income".  Also, the airbnb profits are taxed, not sure if you know that.
 I'd like to see this spreadsheet.   It is very unlikely that it's a wash between the ira and the rental after 20 years.  There's likely a computational error in there.

Nochka

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #4 on: June 29, 2019, 05:59:08 PM »
We continue to look at expenses closely, and I have no desire to leave the corporate world only to work part-time. (I should've mentioned that one of my goals/needs is to home-school my younger son.) The amount we need is about what the second property would generate. Yes, very aware that I will owe taxes on the rental income and that I cannot live off appreciation.

Regarding giving up 40% of our retirement savings to taxes, we will likely pay 30% post-retirement given our expected income and expense levels. So a good chunk of the $1.1M is Uncle Sam's under either scenario. I believe that the hit is really 20% ó 10% for the penalty and 10% for the higher marginal tax rate. (That's assuming tax rates for higher incomes don't go up over the next 20 years, which seems unlikely.)

I'm not surprised to hear agreement that it's totally crazy because my first take was also that it would be crazy. But when I put the numbers in a spreadsheet, they don't appear to be. A computation error is possible so here are the numbers.

We're generating $100K and the only significant expenses after the mortgage are $20K in cleanings, insurance and property taxes. So call it $80K net, or 10% on the $800K before appreciation.

Regarding the appreciation, the property is in the central area of a fast-growing metropolitan area, walking distance to restaurants, groceries, a large park with many concerts and festivals, and a growing number of corporate headquarters. (We've received as much as $2K/night during major events.) Home prices are climbing rapidly and the fundamentals support very strong long-term growth. If the house appreciates at 4% (aggressive for real estate but very conservative for that neighborhood) it will be worth $1.8M in 2039. If our rent and expense grow at 4% we will receive another $2.8M in net income over that period for a total of $4.6M. Lower the assumptions to 3%, which I believe is an extremely conservative case, and it's $1.4M and $2.5M for a total of $3.9M.

If we don't touch the IRA for 15 years, and assuming a 6% CAGR for stocks, our $1.3M would grow to $3.1M at age 63, whereupon I would start a 4% withdrawal and have $3.4M in the IRA after 20 years. During those first 6 years of retirement (2034-2039) my withdrawals would total $0.8M for a grand total of $4.2M.

Long story short, the total money I would receive appears similar. I do concede that my net worth will be significantly lower, but it will still be high and maximizing my net worth isn't my end game. (It's also possible that with a couple years of rental income history and $1.5M in equity I can take a mortgage on the new property and make additional investments, or that the neighborhood will continue its current trajectory, and that the real estate option will significantly outperform these assumptions.)

Having heard that it's crazy, my follow-up question would be: are there any obvious flaws in my assumptions above?

RWD

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #5 on: June 29, 2019, 06:17:02 PM »
Regarding giving up 40% of our retirement savings to taxes, we will likely pay 30% post-retirement given our expected income and expense levels.
Assuming California taxes you would need an annual income of over $400k in retirement to be paying 30% effective rate in taxes. Based on your numbers I find that very hard to believe. But if that is the case I think you are definitely on the wrong forum.

We're generating $100K and the only significant expenses after the mortgage are $20K in cleanings, insurance and property taxes. So call it $80K net, or 10% on the $800K before appreciation.

[...] and assuming a 6% CAGR for stocks
Stocks have historically returned 10%.

lhamo

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #6 on: June 29, 2019, 06:24:29 PM »
You are 48. That gives you 22 years to be playing with Roth conversions to minimize both the tax hit over time and any future RMDs on your traditional retirement accounts.   So it seems to me you are overestimating how bad the tax hit will be on your future money because for whatever reason you have it in your head that this is a great idea.

I mean, whatever.  You do you.  Not my money.

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #7 on: June 29, 2019, 06:44:00 PM »
How about this scenario:  You take your $250K in non-retirement accounts and buy a similar $800K house.   Your mortgage payments will be roughly $32,000/year.    Assuming similar cash flows, you'll net $48K.   Now you can take the 72t withdrawals, and do the Roth conversions, which will save you big bucks in taxes.   

Can you can live on the $48K, the income from the original house, the  72t withdrawals, and your wife's salary?

Another Reader

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #8 on: June 29, 2019, 06:59:51 PM »
Really, really stupid idea.  The economy is hot and the hotel/hospitality market is equally hot.  When the economy hits a rough patch, your occupancy could drop by 50 percent in a short period for BOTH properties and stay at that level for several years.  You need the higher income and you don't have the reserves to get you through an extended major recession.  Hotels are financed by large lenders with commercial loans.  If the SHTF, lenders will restructure loans and do work out agreements with a proven hotel operator.  You?  They will foreclose on a single family residence without batting an eye. 

You could also get a local government elected that does not like hospitality in SFH neighborhoods and restricts you to the point you lose money.

Keep the existing AirBnB property if you must, but find another way to earn a living and work on trimming back your expenses so you can live on less income.  You cannot recover what you will have lost in taxes if your plan fails and you could lose the financed property as well.

Nochka

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #9 on: June 29, 2019, 07:40:48 PM »
Some great insights, thanks all!

Fair point about local regulations. Our state is expected to pass a law soon prohibiting municipalities from regulating them.

Also fair point about a downturn. Because we wouldn't have a mortgage on the second property, it obviously couldn't be foreclosed upon. Our primary residence has a small mortgage, and my wife's income can cover it plus the absolute essentials. Our mortgage debt is concentrated on the current Airbnb. If bookings fell in half at both properties, we'd be where we are today from a cash-flow perspective, with the same mortgage debt and same $100K in Airbnb income. The college savings would cover us for 1-2 years without drastic lifestyle changes, and I'd go back to work.

Regarding taxes, if I am overestimating future taxes and I can keep more of those withdrawals, great. I don't believe that changes this analysis significantly since my spreadsheet had the IRA growing untouched until 2034, and didn't estimate the tax on the $0.8M in withdrawals. I will look into Roth conversions. I only recently moved the money out of a 401(k) so I'm less familiar with IRAs.

A 10% CAGR from the stock market would fundamentally change this analysis and tilt it towards the IRA. I am using Warren Buffet's guidance of 6-7%, since we are in a period of low single-digit GDP growth and inflation.

Quote
How about this scenario:  You take your $250K in non-retirement accounts and buy a similar $800K house.   Your mortgage payments will be roughly $32,000/year.    Assuming similar cash flows, you'll net $48K.   Now you can take the 72t withdrawals, and do the Roth conversions, which will save you big bucks in taxes. 

This! This is what I was looking for! No insults, just ideas! However I probably can't qualify for the mortgage on another $800K house because of our debt-to-income ratio and short rental history. I could take $250K in savings and potentially college savings to do a $400K house, then do the 72t, and net about the same but with much lower risk. It would require some research, as $400K no longer buys a patch of the current neighborhood, so I'd need to target a different one.
 

 

RWD

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #10 on: June 29, 2019, 08:26:48 PM »
A 10% CAGR from the stock market would fundamentally change this analysis and tilt it towards the IRA. I am using Warren Buffet's guidance of 6-7%, since we are in a period of low single-digit GDP growth and inflation.
Didn't Buffett say that in 2003? No one can predict the future but if you're going to assume that markets are going to return less than average then you shouldn't be comparing it to a real estate scenario where nothing goes wrong.

Another Reader

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #11 on: June 29, 2019, 09:18:20 PM »
The stock market has been around for a lot longer than AirBnB has.  Fairly consistent track record over time.

In a severe recession your wife could lose her job and you could be unemployable because of your age and absence from the workforce.  What would losing her job do to your projections?

Bought a lot of foreclosures during the last major downturn because of rosy assumptions that did not pan out.  Suggest you spend some time looking at the worst case scenarios.

Nochka

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #12 on: June 29, 2019, 09:58:20 PM »
Great point about worst-case scenarios and my employability declining with age. Even in a worst-case scenario, where Airbnb is shuttered or banned, I have an attractive long-term rental in a very desirable and fast-growing urban area, and I would own it free and clear. People will always need a place to live, and without a mortgage it can't be foreclosed upon. My other house could be, but it's very hard to imagine the combined rent from both properties not covering the mortgage on that one, even in a repeat of 2008. But it's fair to point out that we should think through what would happen if that occurred AND my wife lost her job.

I was using what I believed were conservative numbers for both real estate and stocks. Arguably more conservative on real estate as our neighborhood is appreciating 3x faster than what I modeled. It's possible the stock market will have a 10% CAGR despite our historically low GDP growth and inflation rates, but that seems optimistic to me.

waltworks

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #13 on: June 29, 2019, 10:25:15 PM »
Lotsa folks think they're RE geniuses right now. I remember how that worked out last time.

Next 3-5 years should be fun.

What I'm saying is: I don't like your plan. You are concentrating almost your whole NW in 2 properties in the same metro area? Holy high risk gamble, batman!

-W

lhamo

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #14 on: June 30, 2019, 08:44:42 AM »
Lotsa folks think they're RE geniuses right now. I remember how that worked out last time.

Next 3-5 years should be fun.

What I'm saying is: I don't like your plan. You are concentrating almost your whole NW in 2 properties in the same metro area? Holy high risk gamble, batman!

-W

Well, including the personal residence there would be THREE properties -- diversification!

Roland of Gilead

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #15 on: June 30, 2019, 08:56:14 AM »
What amazes me about this thread is that someone can be smart enough to amass $1M in a IRA and then dumb enough to consider cashing it in and paying 50% in tax.   Sorry to be blunt.  Don't mess with your IRA.

lhamo

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #16 on: June 30, 2019, 10:24:33 AM »
Perhaps this is a situation where meeting with a fee-only financial planner and/or CPA would be worth the upfront cost to help avoid unnecessary taxes while maximizing income.

Also, not quite sure I understand why the preferred option seems to be to purchase another house rather than paying off the two you already have.  You know the income situation for the current rental.  IF you decide to cash out the retirement funds, why not first get rid of the debt you have, and then save up to add to your rental empire? 

Another Reader

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #17 on: June 30, 2019, 11:28:28 AM »
People do not "always need a place to live."  In the last recession, a lot of people lost their jobs and could not afford a place to live.  Households consolidated, and overall vacancy went up.  Rentals on the lower end of the spectrum became very valuable to combined households, and rents for those properties went up.  Luxury homes and condos?  A lot went to foreclosure when no one could afford the rent and over-leveraged landlords stopped paying mortgages on properties that were vacant and worth less than 50 percent of peak prices.  It took several years for the balance to be restored.

In addition, real estate is cyclical by nature.  It appears we are at or near the peak of the cycle.  Appreciation will come to an end at some point and values may well drop.  Over 30 years you should be ok if you really are in a high demand, growing area, but maybe not over 5 to 10 years.

bacchi

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #18 on: June 30, 2019, 11:49:22 AM »
People do not "always need a place to live."  In the last recession, a lot of people lost their jobs and could not afford a place to live.  Households consolidated, and overall vacancy went up.  Rentals on the lower end of the spectrum became very valuable to combined households, and rents for those properties went up.  Luxury homes and condos?  A lot went to foreclosure when no one could afford the rent and over-leveraged landlords stopped paying mortgages on properties that were vacant and worth less than 50 percent of peak prices.  It took several years for the balance to be restored.

Exactly. The city I lived in had an increase in population but vacancies still went up. It was probably a late surge in building combined with people leasing fewer bedrooms (couples decided they didn't need 2 bedrooms for only themselves, for example, and so on).

When the economy drops, travel will suffer too.

Same as it ever was.

Nochka

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #19 on: June 30, 2019, 01:18:19 PM »
I will stand by my bold assertion that people will always need a place to live. They can choose another property, but with no mortgage I would have the flexibility to charge whatever the market will bear. (People will also need to educate their kids, and we're a short walk to the best public high school in the city.) People keep invoking the specter of foreclosure even though the property would have no mortgage.

Regarding my stupidity, I would argue that simply considering a radical idea and asking for input does not make one stupid. :)

Moving on now but thanks for the feedback. Genuinely appreciative.




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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #20 on: June 30, 2019, 01:39:23 PM »
As you move on, please consider stopping back every year or so and letting us know how this turns out.  After close to 40 years of being professionally involved in real estate and almost 25 years in the rental business, I do think I have a more realistic perspective than you do, but you may have a vision I just can't see.

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #21 on: June 30, 2019, 08:55:20 PM »
@Nochka , I think your ideas have some merit.

First, it's possible with short-term vacation rentals and the new depreciation rules to put very large tax deductions onto your tax return. You might be able on at least your federal return to, for example, shelter $200K or $300K of IRA withdrawal with $200K to $300K of depreciation and related deductions just the first year.

I describe how one can do this in a blog post here: Vacation rental tax shelters. Read that post for gritty details but to summarize, you want to avoid the passive loss limitations and then use cost segregation to massively front load the depreciation.

Second, it seems pretty clear that many of us have underestimated how good the returns historically are on housing investments. The "Rate of Return of Everything" study which came out about a year and a half ago and then the study data which came out a couple-three weeks ago have changed my thinking. (Relevant disclosure: I prepared for my own retirement not using real estate but using cheap stock index funds and SEP-IRA accounts.)

But real estate and housing obviously deserve more respect than they often get from equities-focused investors...I put together some line charts that show stock, housing and bond returns for 14 countries over roughly the last 100 years and housing returns most of the time beat stocks. Those line charts appear in a blog post I did here, Rate of Return of Stocks, Housing and Bonds for 14 Countries over Last Century.

Note: There's thread at Bogleheads right now discussing the "Rate of Return of Everything" paper and at the very end of the thread here, the Boglehead SimpleGift nicely summarized the relative returns of investments in stocks and housing from my summaries at the aforementioned blog post..

A caution... it would be easy to screw up the tax accounting on this. Some gotchas exist (like depreciation recapture.) Also the deductions and IRA withdrawals won't perfectly balance out so you might get hit with some penalties.

And then this comment... While I think conceptually what you propose would work--and I've considered something similar myself--smart tax planning wouldn't make a so-so rental property purchase into a great investment... Smart tax planning would only let you do what you want to do without the tax burden that some posters worry about.

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #22 on: June 30, 2019, 09:27:00 PM »
Please consider the fact that something could change in your personal situation (your health, or a family member's health, for instance) to make managing the vacation rental no longer possible for you.

I'm retired with income from a mix of traditional retirement accounts and a vacation rental, and I like that diverse mix. But my husband has no interest at all in managing the vacation rental, and if I were no longer able to manage it, he'd probably want to sell--whatever the market conditions were at the time. Bye-bye rental income, but not a big problem because the traditional retirement accounts would keep on generating income.

Since you like managing the airbnb, you might consider offering your management services to one or two other owners, and generating some income that way.
« Last Edit: July 01, 2019, 09:10:36 AM by jodelino »

theoverlook

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #23 on: July 01, 2019, 08:20:31 AM »
No no no, cashing in the IRA is a terrible idea.

We continue to look at expenses closely, and I have no desire to leave the corporate world only to work part-time.
Yet you're talking about paying to buy a part time job.
Quote
We're generating $100K and the only significant expenses after the mortgage are $20K in cleanings, insurance and property taxes. So call it $80K net, or 10% on the $800K before appreciation.

Zero in income taxes, zero in maintenance? An $800k house with hundreds of people going through it does not have a $0 maintenance bill. A typical single family home, which would have much lower wear and tear than an AirBnB home, is estimated at about 1% of home value in maintenance, so $8000. Income taxes are going to be significant.

Work on your expenses.

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #24 on: July 01, 2019, 09:26:11 AM »
No no no, cashing in the IRA is a terrible idea.

<snip>

Income taxes are going to be significant.


Do folks understand that Nochka can use the giant depreciation deductions produced by a short-term rental to shelter draws from the IRA?

BlueHouse

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #25 on: July 01, 2019, 10:02:34 AM »
Do folks understand that Nochka can use the giant depreciation deductions produced by a short-term rental to shelter draws from the IRA?
I really don't understand why he wants to put his own money into the second house instead of leveraging someone else's money. 

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #26 on: July 01, 2019, 10:47:28 AM »
No no no, cashing in the IRA is a terrible idea.

<snip>

Income taxes are going to be significant.


Do folks understand that Nochka can use the giant depreciation deductions produced by a short-term rental to shelter draws from the IRA?

He is going to cash out his entire $1.1M Ira and combine that with his cash on hand to buy a $800k property.  That's a used property, not a new one, and the land may comprise a substantial amount of the total property value.  You propose a cost segregation analysis to accelerate the depreciation of part of the improvements to write off against the income generated by cashing out the IRA. 

I assume you have done cost seg studies on SFR's and have some experience with defending them.  I would like to see your analysis and the numbers that you think would result from this approach for a typical $800k single family residence in your market.  My guess is the tax and penalty bite after your adjustments would still make this plan unattractive to most reasonable people.

redbirdfan

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #27 on: July 01, 2019, 10:29:06 PM »
If you are currently unemployed, and you are dead-set on the AirBNB route, you can consider converting your traditional IRA to a self-directed IRA and buying the property with your self-directed IRA.  Shop in around on the tax forums, get outside tax advice and read up on it.  You will lose depreciation, but if you sell the property before 70.5, you won't have to pay cap gains taxes or worry about doing RMDs with real estate.  You CANNOT self-deal which means neither you nor your linear relatives (kids, grandkids, parents, grandparents, etc.) can stay in the house or do any "blue collar" work on the house.  All expenses must come out of the SDIRA. You could buy the property partially with your SDIRA and partially with outside funds...again, get pro advice.  Make sure you don't offer any services that convert the Air BNB to a business as opposed to passive rental income.  You could even get a non-recourse loan for the property.  You could possibly structure Roth conversions to cover your living expenses to allow you to stay home.  You can get creative, but there are lots of pitfalls with this method. 

Again, seek professional help if this is something you'd consider.  Do a search at Bigger Pockets for self directed IRAs and consult with a CPA familiar with the issue.   
« Last Edit: July 01, 2019, 10:31:22 PM by redbirdfan »

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #28 on: July 02, 2019, 08:37:54 AM »
No no no, cashing in the IRA is a terrible idea.

<snip>

Income taxes are going to be significant.


Do folks understand that Nochka can use the giant depreciation deductions produced by a short-term rental to shelter draws from the IRA?

He is going to cash out his entire $1.1M Ira and combine that with his cash on hand to buy a $800k property.  That's a used property, not a new one, and the land may comprise a substantial amount of the total property value.  You propose a cost segregation analysis to accelerate the depreciation of part of the improvements to write off against the income generated by cashing out the IRA. 

I assume you have done cost seg studies on SFR's and have some experience with defending them.  I would like to see your analysis and the numbers that you think would result from this approach for a typical $800k single family residence in your market.  My guess is the tax and penalty bite after your adjustments would still make this plan unattractive to most reasonable people.

Here's how I'm looking at @Nochka 's idea. He's talking about adding a second short-term rental. To buy that, he will use $250K of cash and then draw enough cash from his IRA to pay the other $550K. He assumed he needed to liquidate a $1.1M IRA in order to pay 40% income taxes and a 10% penalty.

I'm pointing out that on that second $800K house, a cost segregation study may point to, who knows, $250K or more of personal property that can create $250K of bonus depreciation in year of purchase. He'll also get another roughly $10K a year of depreciation on the real property.

And then he's got that first $800K house... a cost segregation study for that house may also create $250K of more of personal property. Probably that house he owned before the cutoff date for using 100% bonus depreciation on used property. But even so, he should get very large depreciation deductions from the cost segregation study especially in years 2 and 3.

Finally, he surely has furnishings in the first property (say those are $60K for illustration purposes) and will also need furnishings for second property (again say $60K)... those can very possibly be depreciated either immediately or very quickly using bonus deprecation.

Summing up, taxpayer may be able to put $300K to $400K bonus on first year tax return and then very large regular depreciation numbers on years 1, 2 and 3. That depreciation may let him shelter from income taxes the $550K he needs.

The early withdrawal penalty still applies in scenario like that described above. So tradeoff is, does something like a Section 72(t) distribution create an opportunity dial down the penalty.

In any case, the combination of taxes and penalties doesn't come anything close to the $550K figure @Nochka gave and which I think people thought was "the right number"... The actual number is maybe $55K for the penalty unless he can work the Section 72(t) angle. (Obviously, that $55K is still a lot.)

Regarding @Another Reader 's question about cost segregation studies and defending them... so when we see cost segregation studies, almost always, an engineer does the study. (They cost several thousand dollars.) And though I've yet to see a small real estate investor audited on a cost segregation study issue, what the engineers say is they will defend their study and guarantee the outcome. (Yeah, yeah, I know they can't really provide a guarantee... but that's what they say.)

Regarding @redbirdfan 's remark about self-directed IRAs... Almost all of my personal professional experiences with self-directed IRAs has been bad. (Our firm BTW does 990-T returns for self-directed IRAs.) They get set up wrong. They get mismanaged. They create complexity that overwhelms most small investors. FWIW, I have in past diligently searched for a tax practitioner who (a) knows her or his stuff and (b) actively practices in this area... and I've not been able to find someone I have confidence in. Sorry.

radram

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #29 on: July 02, 2019, 04:21:04 PM »
Cashing out your IRA is a decision that is irrevocable if it doesn't work out. I do not like those types of decisions, especially when I am ruling the world like you are. $1.1 million in an IRA at age 48 is ass kicking bad-assity, worthy of 2 ass references(or was that 3?)! Nice work there.

To me it just doesn't seem worth the risk to remove all your retirement savings for this plan, even if the numbers work if your favor.

I have another idea you could explore. I originally had 2 ideas, but the other was to buy a property inside your retirement account. I know the downsides are many as already mentioned. One downside is you can not be the one doing the work, which defeats the purpose of you running another AirBnB. But it DOES create a REVOCABLE decision in that it could be sold and kept within your retirement vehicle, most likely at some form of loss if done quickly. @SeattleCPA has depth on this subject already added that I can not touch. He states strong ideas on how to make it work instead of just saying you are an idiot... stop thinking that way. They may have meant to do so in a face-punch kind of way, but I understand why you may have gotten discouraged and may have even stopped looking at this thread. I am also guilty of once attacking a person instead of an idea, something that I still think about often with regret. Here's to hoping you get more responses like Seattle provided.

If you are still here, other idea:
You want to run 2 AirBnB's? Move out of your house for 1 year, get a rental, closer to your wife's work, and draw $0 of your retirement and $0 of your $250,000 stache. Spend might increase with rent, but it will be offset by increased income. Downside is you rent instead of own your primary residence. Upside is you get your 2 rentals, and it is easily revocable by just letting your rental lease expire and move back in to your home. 

In your position, I would be making choices that can be reversed with little effort with costs that would be worth the risk. I have not yet heard of one that is worth that risk of removing a million in tax free growth for what could end up being 50 years. YMMV.

Keep us posted.


SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #30 on: July 02, 2019, 05:43:34 PM »
@radram 's comment makes me share one other thought about how Nochka's idea might work.

I wonder if a series of payments that work for Section 72(t) isn't rather optimal if Nochka did go ahead with something like this.

In that case, the 48 year old investor figures out what depreciation deduction he can put on the next eleven tax returns (until age 59.5 or whatever)... Say that's $40K a year...

Taxpayer then draws $40K at closing to dial down mortgage balance or to furnish property... and then $40K on January 1 of next ten years/ 1/1/2020, 1/1/2021, etc. to pay down mortgage. These income amounts get sheltered by the $40K of depreciation. And the substantially equal payments that last until either five years go by or until age 59.5 let him sidestep the penalty.


Spitfire

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #31 on: July 03, 2019, 12:01:01 PM »
If those depreciation deductions cause a current year loss on the rentals, can that offset the IRA withdrawal income? Or would it be limited as a passive activity?

Kem

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #32 on: July 03, 2019, 12:52:55 PM »
Just saying, you can sell 800K house and buy a NICE 250K home in NW Indiana.  Put remainder ~500K in TOD VTI and begin roth conversion ladders on your 1.1M holding.  You and you wife could retire today and live a very comfortable lifestyle.

Then... In 5 years when first ladder hits if the housing market is correcting you can snag at 5:1 a handful of units at 1-2% .  Now you have not only a very comfortable life, but a legacy too.

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #33 on: July 03, 2019, 02:06:31 PM »
If those depreciation deductions cause a current year loss on the rentals, can that offset the IRA withdrawal income? Or would it be limited as a passive activity?

Typically, the Section 469 passive limitation rules say you can't use rental losses (from stuff like depreciation) to shelter other income (like from IRA withdrawals or a job)... a handful of exceptions to the usual rules though. One is when the average rental period is 7 days or less.

This whole subject btw is what my blog post linked to earlier explains: https://evergreensmallbusiness.com/vacation-rental-tax-shelters/

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #34 on: July 03, 2019, 02:13:35 PM »
Just saying, you can sell 800K house and buy a NICE 250K home in NW Indiana.  Put remainder ~500K in TOD VTI and begin roth conversion ladders on your 1.1M holding.  You and you wife could retire today and live a very comfortable lifestyle.

Then... In 5 years when first ladder hits if the housing market is correcting you can snag at 5:1 a handful of units at 1-2% .  Now you have not only a very comfortable life, but a legacy too.

OK, I like the idea of just downsizing the spending footprint in general. So not one but two thumbs up on that notion.

However, converting $1.1M of tax-deferred accounts to Roth accounts would absolutely be the way to pay a boatload of income taxes.

Kem

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #35 on: July 03, 2019, 02:53:31 PM »
First handful of years will be covered on house cost savings and equity return.   You can stretch this by putting 20% down and investing that difference too.

Ladder would be over time so tax would be spread out hopefully at the rate of tax defferal hits anyways / so wash on the taxation.  Planned right, you could pull just enough out of the ladder to pick up a few leveraged rental units at which point you'd be able to leave the ira alone if desired.

powskier

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #36 on: July 03, 2019, 08:48:26 PM »
I'm assuming your $1.1M IRA is well diversified. Turning a well diversified chunk of change into a very concentrated, illiquid asset seems to be a risky proposition.

All these ideas seem great in hot RE markets but when things turn based on unforeseeable happenings ownership of RE can be a burden.  Don't ask me how I know..................

Kem

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #37 on: July 04, 2019, 06:00:36 AM »
Another thought is take the geo arb and skip the rentals.  One can still live a very comfortable retirement in areas of the country on 1.6M and no debt (or a bit more and a 200k mortgage)

KBecks

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #38 on: July 04, 2019, 06:27:00 AM »
How does your spouse feel about using the kids' education funds as emergency back-up, or as fuel for the plan?

SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #39 on: July 04, 2019, 08:33:45 AM »
I'm assuming your $1.1M IRA is well diversified. Turning a well diversified chunk of change into a very concentrated, illiquid asset seems to be a risky proposition.

All these ideas seem great in hot RE markets but when things turn based on unforeseeable happenings ownership of RE can be a burden.  Don't ask me how I know..................

So @Nochka ? When you first asked about this idea, people pointed to two roadblocks or issues: the heavy taxes you'd paid and the risks of an entrepreneurial investment.

I think we've pretty much shot down the "tax" thing. As I noted in my very first comment in this thread, you could ignore the taxes probably (if you did this right)... the question is, does the investment make sense...

Regarding the idea that this is too risky, that's a personal call. But I guess I look at what you've described and think your idea to reasonable to consider thinking about--and maybe even pursuing. You're not in the end going to vaporize your $1.1M... you're going to maybe use half of it (thereby leaving the other half intact.). You've got that trust, possibly, out there somewhere in the financial future.

Understandably and, I'm sure, with good intentions, folks are cautioning you about the risks of starting a business. But people do start businesses and succeed.

A note: That recent study, "Rate of Return of Everything," which I've been talking up in other threads says our portfolios will probably all do better with an allocation to housing. Most people can't swing that. You can. BTW, the 100 year returns for the Netherlands, one of the country's described in the study, show the usual case: Housing beats equities:



Two other comments about this, too. First, the idea to geo arb, which is an interesting one, surely has risks too. Probably you're living someplace HCOL with access to high-wage jobs. There's a hidden risk in relocating to a LCOL area where those jobs won't exist. (That "risk" may make every other financial risk immaterial... Given your savings, I would image your potential earnings in the next decade are enormous.)

Also, and displaying my financial conservatism, I would wonder about (sorry) going back and getting a job temporarily, using your income to qualify for a loan on that next rental, etc. etc., and then look at exiting corporate world.

P.S. Anyone interested in seeing the line charts for the other countries I could graph can peek here: https://evergreensmallbusiness.com/rate-of-return-of-everything-study-in-line-charts/

Roland of Gilead

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #40 on: July 04, 2019, 08:52:11 AM »
I am not really convinced on the charts that show housing beating equities.

What about maintenance on the house?   Not many stocks require you to put a new roof on them every 30 years, or mow their lawn.

Are dividends included in these studies?

How do you buy a diversified house?  A index house if you will?   It looks great if you bough a house in southern California in the past decades but not so great if you bought in Detroit.

iris lily

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #41 on: July 04, 2019, 09:28:02 AM »
I donít understand why more people arenít afraid of the Airbnb market crashing. Everyone is getting into Airbnb. It cannot  possibly be sustainable that everyone makes money.

KBecks

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #42 on: July 04, 2019, 09:46:44 AM »
I am super impressed that the OP has a successful AirBnB going on right now.  But it's important not to overstretch and it sounds like they're not ready for #2.


SeattleCPA

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #43 on: July 04, 2019, 12:33:38 PM »
I am not really convinced on the charts that show housing beating equities.

What about maintenance on the house?   Not many stocks require you to put a new roof on them every 30 years, or mow their lawn.

Are dividends included in these studies?

How do you buy a diversified house?  A index house if you will?   It looks great if you bough a house in southern California in the past decades but not so great if you bought in Detroit.

Roland, so I was initially disoriented by the recent study's info... for what that's worth. But the data looks pretty robust to me.

BTW, the equity returns do include dividends. Housing returns include all expenses except property taxes which the authors say probably reduces the return by 1% on average. Also, they talk about the impact of not being able to buy a country-wide index and how that impacts returns.

Some links:

The actual Rate of Return of Everything: 1870 to 2015 paper (pdf)
My blog post that summarizes the study: Lessons from the Rate of Return of Everything paper
The webpage where you can download the actual data, including an Excel spreadsheet of Rate of Return Everything data
My blog post that graphically depicts some of the data you can download: Rate of Return of Everything Line Charts.

A couple of interesting, at least to me, forum discussions to mention. The Bogleheads Rate of Return of Everything thread... and then the thread we had last week here at MMM about how equities can lose money even if you invest for a looong time

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K-ice

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #45 on: July 06, 2019, 01:59:07 AM »
I really don't understand why he wants to put his own money into the second house instead of leveraging someone else's money.
^^^ This

I know the OP didnít think they could get a mortgage on another $800K house but they do have $200K cash.

I would see what else you could leverage from your two current properties, add that to the cash & there is your budget for property #3. You might even be able to get a mortgage on property 3 based on conservative rents.

But ideally you are not over leveraged & my goal would be to have my primary residence mortgage free & let the rentals pay for themselves slowly.

If you enjoy managing an AirBnB itís not a bad idea. Can it be done with more baby steps & not cashing out your life savings for another $800K property?

waltworks

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #46 on: July 06, 2019, 07:39:00 AM »
I donít understand why more people arenít afraid of the Airbnb market crashing. Everyone is getting into Airbnb. It cannot  possibly be sustainable that everyone makes money.

+1. We quit the Airbnb thing after about 15 months when we realized we were getting the same return we would from renting long term, even *without* accounting for our time/effort. Who wants to clean and vacuum for a few hundred hours a year instead of just basically doing nothing for the same money?

I think a lot of people doing Airbnb are just really bad at accounting for their actual expenses and/or willing to clean their place for free or something, because we were competing with people who were renting similar places to ours for even less (and hence presumably making even less money).

-W

ender

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #47 on: July 06, 2019, 07:46:53 AM »
I donít understand why more people arenít afraid of the Airbnb market crashing. Everyone is getting into Airbnb. It cannot  possibly be sustainable that everyone makes money.

Just look around at how many hotels exist - I highly doubt Airbnb will come close to that many available rooms/options available in a loong time.


theoverlook

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #48 on: July 09, 2019, 12:32:10 PM »

A note: That recent study, "Rate of Return of Everything," which I've been talking up in other threads says our portfolios will probably all do better with an allocation to housing. Most people can't swing that. You can. BTW, the 100 year returns for the Netherlands, one of the country's described in the study, show the usual case: Housing beats equities:





I may have missed something, but I'm confused by your use of the Netherlands rather than the United States here. In the US, equities handily beat housing in returns in all periods since 1919 per your graphs.

Sibley

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Re: Cashing out a $1M IRA early to buy an Airbnb?
« Reply #49 on: July 09, 2019, 12:50:29 PM »
@Nochka , have you ever heard that when you've lost a loved one, you should avoid making big decisions as much as possible for a year? When you're grieving, you don't think very well, and can essentially be temporarily insane.

I think you're grieving. Don't make any big decisions for at least 6 months.