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Pay No Tax on Roth IRA Conversion

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Pay No Tax on Roth IRA conversionI’m about to blow your mind today. I have been wondering if I could contribute to my i401k and do a Roth IRA conversion in the same year. Mrs. RB40 is planning to retire soon and I want to start building a Roth IRA ladder when she does. I wasn’t sure if there would be any benefit to doing these two things at once.

  1. Contribute to my i401k – We would defer tax.
  2. Roth IRA conversion* – We want to build a Roth IRA ladder so we can avoid the 10% early withdrawal penalty.

Normally, you have to pay tax when you do the Roth IRA conversion. I thought we would be in the 15% bracket and wouldn’t have to pay much tax. However, it turns out much better than that. We won’t have to pay any additional tax on the Roth IRA conversion. That’s mind blowing! How can this be possible? First, let’s review why we want to build a Roth IRA ladder and then I will show you how to pay no tax on a Roth IRA conversion.

*The conversion will be from my traditional IRA to Roth IRA. I rolled over my old 401k into a Roth IRA when I left my job. All the money in this account is pre-tax.

Roth IRA ladder

If you’re like us, you have invested a lot of money in your tax-deferred retirement accounts. I have been maxing out my 401k for 20 years and there is a sizeable sum in there. The problem is when you retire early (before 59.5), you will need to pay the 10% early withdrawal penalty to access those tax-deferred accounts. A great way to avoid the 10% penalty is to build a Roth IRA ladder. Here is how it works.

  1. Convert 1 year of living expense from the tax-deferred accounts to Roth IRA. (This is a taxable event.)
  2. Wait 5 years
  3. Withdraw the 1 year of expense from the Roth IRA

Just repeat this every year until your 59 ½. The reason you don’t have to pay the 10% penalty is because the penalty doesn’t apply to your contribution to the Roth IRA. For conversion and rollover, this exception kicks in after 5 years. That’s why you need to wait 5 years to withdraw.

There is a big drawback to this process. You will need fund 5 years of living expenses before you get the first penalty free withdrawal from your Roth IRA. Also, the Roth IRA conversion is a taxable event. That means you need to pay tax on the amount you convert. This is bad because your fund will be drained by living expense plus the tax on the conversion.

The Roth IRA has other major advantages. The Roth IRA is a tax-free account. That means you don’t have to pay tax on the earning. Also, the Roth IRA is not subject to Required Minimum Distribution so you won’t be forced to withdraw from it in your lifetime.

Pay No Tax on Roth IRA Conversion

When Mrs. RB40 retires, our earned income will drop quite a bit and it would be a good time to start our Roth IRA ladder. You pay less tax when your income is low. Here is our tax profile from 2015 after I remove Mrs. RB40’s W2. I also removed the one time Hi-Tech antitrust settlement.

Income: $32,000

  • Dividend: $10,500
  • Interest: $1,500
  • Business Income: $36,000
  • Rental: -$16,000

Adjustments: ($27,044)

  • Self-employment tax: $2,544 (This is 50% of my self-employment tax liability.)
  • 401K contribution: $24,500

Deductions and Exemptions: ($32,790)

  • Mortgage interest: $9,177
  • State and local taxes: $11,528
  • Personal exemptions: $12,000

Credits: ($1,000)

  • Child tax credit: $1,000

Taxes: $5,161

  • Self-employment tax: $5,087

Here is an easier to read format from the H&R Block tax summary page.

Pay no tax on Roth IRA conversion

Now, let’s add the Roth IRA conversion to the mix. I will convert $36,000 from my traditional IRA.

Pay no tax on Roth IRA conversion

Do you see the magic? Our income increases from $32,000 to $68,000, but the amount of tax owe remains the same. I just moved $36,000 from my traditional IRA to my Roth IRA. This is huge because it means I won’t have to pay tax on the conversion. We can keep doing this for 20 years and all our tax-deferred funds will be moved to our Roth IRA. I just transformed tax-deferred to NO TAX without having to pay anything! If this isn’t mind blowing, I don’t know what is.

Can this be replicated?

As I disclaimed, I am not a tax expert, but there seems to be 3 key points why this works.

  • We have too much adjustment, deduction, and exemptions. In the first table, our taxable income drops to zero. We couldn’t take advantage of everything because our income would be too low. A big factor is the $24,500 contribution to my i401k.
  • You can’t avoid self-employment tax (15.3%.) We have to pay self-employment tax even if our taxable income is zero. At this point, we could bring in $36,000 more and the total tax would stay the same. The $36,000 could come from any taxable sources, including part time work and IRA conversion. Actually, I’m not exactly sure why the tax isn’t increasing. If I change the conversion amount to $40,000, the tax liability would increase a little. It seems $36,000 is near some sort of threshold. I’m depending on H&R Block to get this right.
  • Rental properties. Our rental income shows up as negative due to property depreciation. This decreases our taxable income.

Whew, I hope I didn’t lose too many people. Tax is a boring topic, but finding ways to pay less tax is very exciting to me. A lot of my 401k contribution came from when we were in the 25% and 28% bracket. Deferring the tax and then not having to pay tax on it is huge. Tax is one of your biggest expenses and if you can avoid it legally, you get to keep more of your hard earned money.

I admit my situation is a little unorthodox, but it could be replicated. If you plan to retire early, you should consider starting your own business and investing in rental properties. These two things will help you bridge the 5 years gap in the Roth IRA ladder and you’d pay less tax as a bonus. Of course, I prefer to make more money and pay more tax, but life is what it is. I’m happy making just enough and not paying a lot of tax as well.

Does this sound legitimate to you? If you know other unusual ways to minimize tax, please share it with us.

Disclaimer: I am not a tax accountant and there is a chance that I could be wrong about this. If you are a tax expert and see a problem, please let me know.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, the job became too stressful and Joe retired from his engineering career to become a stay-at-home dad/blogger at 38. Today, he blogs about financial independence, early retirement, investing, and living a frugal lifestyle.

Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.

Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.

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{ 58 comments… add one }
  • Cookie Rojas August 15, 2019, 1:11 pm

    I’m 24 and have 1,500 in pretax accounts sponsored by former employer labeled:
    – Employee pre-tax vesting — 100% immediate vesting
    – Employer vesting — 100% immediately vested

    Can I roll these over to a Roth? I expect to have zero taxable income this year. Would I face no taxes nor penalty? I will not make withdrawals until I retire at 40 😉

    Tax savings is secondary. Primarily I’d like to consolidate everything into a single Roth, where I’ll make ongoing contributions once I find another job. I just don’t want to pay a dime to Unc Sam unnecessarily.

    Thank you, CR

    • retirebyforty August 15, 2019, 2:30 pm

      I’m pretty sure you can. Why don’t you call your brokerage and ask them to double check. I’m with Vanguard and First Trade. They are both pretty helpful, usually.

      • Cookie Rojas August 16, 2019, 6:39 am

        I did and they were uncharacteristically forthcoming; tax is usually the third rail when it comes to investment advice. As with every case, the answer was “probably”, making numerous assumptions. I don’t see any exceptions that apply unless I get a massive inheritance tomorrow. A guy can dream. Thanks!

        • retirebyforty August 16, 2019, 7:00 am

          Right. You probably can get good tax advice from a CPA. Everyone’s situation is different so I can’t really give good tax advice. I’m not an expert either. Good luck!

  • Brian July 7, 2017, 1:49 pm

    I have thought about become self employed, and becoming a 1099 contractor in order to leverage the employer contribution to the 401k to contribute as much as possible.

    In your case it looks like you are doing just that, contributing a large part of your business income directly to 401k. Is this as an S-CORP? I have read that the IRS expects in this case, that you pay yourself a “reasonable” salary. Have you explored what that might mean?
    Actually I realize some of the 24k 401k contribution must be an employee contribution, but since you are over 18k, you have at least 6k in employer contribution, so 17% employer contribution. I suppose that is reasonable after all… I might not understand how 401k works when you are the employer and employee. Any ideas on that would be great.

    • retirebyforty July 7, 2017, 4:19 pm

      No, this is not an S-corp. It is a sole proprietor. I might change it to S corp if the Trump tax cut comes through.
      You can contribute 25% as an employer. That’s after all the deduction and employee contributions, though. There are some good calculators on the internet. Here is a simple one from Vanguard.
      https://personal.vanguard.com/us/SbsCalculatorController

  • Steve April 12, 2016, 7:48 am

    Here’s my attempt to explain what’s going on:

    Taxable income: $32,000
    Adjustments: $27,044
    AGI: $4,956

    Deductions/Exemptions: $32,790
    “Taxable income” = AGI – Deductions = (-$27,834)

    If you convert $37,834 from traditional to Roth, you’d have +$10,000 in taxable income.
    In the 10% tax bracket, you’d owe $1,000 in taxes. You have a $1,000 tax credit, making your tax liability $0.

  • No Nonsense Landlord April 8, 2016, 9:32 pm

    My rental income is a bit too high to get away with no tax, but I am still planning on doing some conversions. the tax rates are likely to be much higher in the future.

  • James April 7, 2016, 10:26 am

    In your theoretical model, you’re purposely increasing your family income in order to do the Roth conversion “tax free” once your wife retires. However, what is your plan for medical insurance for the family after you’re not on her employer plan? Just buy the coverage on your own or try to get into a subsidized affordable health care exchange plans. I would think $32k annual income for a family would qualify for a decent annual subsidy which you may lose out if you increase your income to do a Roth conversion. The tax savings may actually end up costing you more if you run the actual numbers.

    • retirebyforty April 7, 2016, 11:55 am

      You’re right. ACA will complicate things. We’ll probably have to go through it once and figure out how much benefit we could expect. I think you’re correct that the ACA benefit would be a little more than the no tax on Roth conversion. The amount might not be very big, though. Also, Roth is nice because you won’t have to pay tax on the earning in the future.

      • JeffD September 29, 2019, 11:36 pm

        I’m also wondering how the elimination of state and local tax deductions might have thrown a wrench into these plans. Maybe there needs to be an updated article considering the effects of ACA and the new tax law?

        • retirebyforty September 30, 2019, 10:08 am

          I’ll have to run the numbers again, but I don’t think it will change much.
          The personal deduction for married filing jointly is $24,000. That’s pretty good.
          We should be able to do this trick if the law doesn’t change.
          Not sure about ACA, though.

  • Financial Slacker April 7, 2016, 10:01 am

    I may be a little off topic, but can you discuss what asset types you hold in your IRA? I have always held stocks, bonds, mutual funds, etc., but I would like to look at using my IRAs for real estate.

    I assume you lose the tax advantages of real estate when you hold in an IRA. Any differences between holding real estate in a Roth IRA vs a traditional IRA? Any other reasons to do this or not?

    Thanks.

    • retirebyforty April 7, 2016, 11:50 am

      I have low cost Vanguard index and bond funds in my IRA. Real estate might be a good idea. I don’t have any experience with that, but real estate is usually good in general. Sorry, I’m not more helpful.

  • Joe Y. April 7, 2016, 8:30 am

    Anther option to share – There is an exception to take money out of 401k if you leave your company the year you turn 55 or older without having to pay the 10% penalty. I am 55 now and plans to leave my engineering job after working in the same company for 25 years. Once I leave, I can take money out of my 401k anytime, any amount at a lower tax bracket without having to pay the penalty. I had called Fidelity and confirm it.

  • Vic @ Dad Is Cheap April 6, 2016, 11:17 pm

    Very timely post for me Joe!

    I recently got a job at the end of February after being laid off a few months. I thought now would be a great time for me to do my Roth conversion while maxing out my 401k contributions this year to take advantage of my lower income. I hope to reduce my taxes as much as possible 🙂

    Thanks for the insight!

    • retirebyforty April 7, 2016, 11:45 am

      If you got a new job, you might want to hold off for now. You can always do it at the end of the year if it makes sense.

  • JC April 6, 2016, 8:38 pm

    That’s awesome. Talk about a great loophole. Invest pre-tax dollars then convert to a Roth with effectively no tax because your income is “too low”. Too many people are bored by taxes, understandably so, but they’re leaving so much $ on the table by not becoming educated on them.

    • retirebyforty April 6, 2016, 10:10 pm

      Yes, it’s a big loophole for early retirees. Although, if I take out my business income and rental, then I would have to pay a little tax on the conversion. Tax is boring and I’m ready to stop thinking about it for another 11 months. 🙂

  • jb82 April 6, 2016, 8:03 pm

    Your tax isn’t increasing because of qualified dividends I presume. Taxed at 0%.

    You could probably increase your conversions even more and take advantage of the savers credit at that income level to wipe out additional tax.

    If youget an aca subsidy this complicates things as roth conversion will in effect be ‘taxed’ at something like 14% as they will decrease your subsidy by 14c for every dollar. Something to think about for early retirees.

    • retirebyforty April 6, 2016, 10:01 pm

      Okay, I checked and saver’s credit does not offset self employment tax. We’d have to have some earned income to get that credit.
      Hmmm.. I didn’t know that about the ACA. I will need to look into it.

      • jb82 April 7, 2016, 7:15 am

        Yes it doesn’t apply against self employment tax. However if you increase your roth conversions even more you will have taxable income. You have earned income via your business. So you should be able to claim the savers credit I think.

        • retirebyforty April 7, 2016, 11:49 am

          Business income is not earned income. It is self employment income. I guess we could convert to S corp and issue W2… That seems complicated, though.

          • jb82 April 8, 2016, 9:31 pm

            Yes it is not earned income but it is income. You do not need earned income for the savers credit in any case. You just need taxable income, contributions to certain plans/iras and have not distributed over the past 3 years more than you contribute this year.

  • Smart Money MD April 6, 2016, 6:21 pm

    Joe,

    Just curious about the rental income depreciation. Is the rental property under just your name or a partnership with the Mrs? I had thought that any losses from rental income could not be used to reduce your overall tax burden from your regular active income. Is there a piece that I’m missing?

    • retirebyforty April 6, 2016, 9:41 pm

      All the rentals are under both our names.
      It depends on your AGI. If your AGI is low, you can use rental losses to offset earned income. Here is what I found online.
      Investors with an adjusted gross income (AGI) of less than $100,000 can use passive real estate losses to shelter up to $25,000 of income from other sources. For taxpayers with between $100,000 and $150,000 of adjusted gross income, this shelter has been phased out. For each two dollars of AGI over $100,000, the $25,000 limit is reduced by one dollar.

  • Nathan April 6, 2016, 6:18 pm

    I’m a huge fan of Roth IRA’s. If I could I’d move everything to post tax dollars, but I don’t want to take on the tax burden.

    There is another way to accomplish your goal. You can overfund your 401k. Legally, you can add somewhere between $50k and $55k (I’m not sure which it is). Anyway, max our pre-tax at $18,000, then take post tax money and invest it into your 401k. It’s not a Roth yet, but when you leave your employer, that after tax money can be converted into a Roth without taxation. Or don’t max out pre-tax and put all the money into your 401k post tax.

    I did this last year with my post tax 401k money. It’s a great way to actually invest much more money each year into a Roth without any tax consequences.

    • retirebyforty April 6, 2016, 9:43 pm

      As some comments mentioned above. When you do a conversion, you need to take the pre-tax 401k into account as well. The IRS consider the 401k as one pot so it will be some kind of ratio. Check with your tax guy.

    • Joe April 12, 2016, 2:54 pm

      Nathan,
      I have never heard of that. Is there a resource that spells this out? I am finding that I know more than my tax accountant on these kind of topics, and I always like to present her with hard data/resources. Thanks!

  • Dan April 6, 2016, 5:11 pm

    Joe – been following along for a while but first opportunity to post. Great topic and opportunity to minimize tax. I’m wondering, under this scenario, how you would fund your normal living expenses. Since a majority of business income is sent to your 401K would you draw on your rental taxable accounts or some other savings to fund your actual expenses? I might be missing something but it’s the question that came to mind as I thought through this. Thanks and keep up all the great work here!

    • retirebyforty April 6, 2016, 6:27 pm

      That’s a great point. I estimate we’d have around $25,000 from dividend, rental income, interest, and whatever is left from business income after tax and 401k. That’s not quite enough. We’d probably have to cash out some bonds and sell some dividend stocks to cover the rest of our living expenses. Also, we could draw on our existing Roth IRA. That should be enough to last 5 years until the ladder kicks in.

  • Dividendsdownunder April 6, 2016, 4:12 pm

    Hey Joe, very interesting to read, thanks for sharing. As an Australian the details are a little hazy to understand but I follow your logic. It’s interesting how this system is possible.

    As a separate point, do you think this process should be allowed to be possible?

    Tristan

    • retirebyforty April 6, 2016, 6:22 pm

      It’s a surprise to me and I’ve been filing tax for 20 years. I’m sure your tax code has its own strange points.
      Well, I think this process is okay. The self employment tax seems like a unique case. We have to pay self employment tax no matter how much we make. If this was earned income, my tax would be much less than $5,000.

    • Joe April 12, 2016, 2:52 pm

      Tristan,
      Sorry for the late response. I have been offline for awhile. Yes, I believe the process should be allowed. It’s an opportunity in the tax code that one should seriously consider to maximize retirement savings.

  • Believe Fire April 6, 2016, 3:44 pm

    Wow, nice job minimizing taxes! I’m going to have to reference this post down the road. It’s awesome how much of a deduction you’re getting from your 3 rentals. We’ve been wanting to get into real estate and we’ll have to get started after we finish traveling the world this year.

    • retirebyforty April 6, 2016, 6:20 pm

      The deduction is nice if you can take advantage of it. The property tax around here is pretty high.

  • Sam @ Financial Samurai April 6, 2016, 11:57 am

    My mind is blown b/c I feel too dumb to follow the logic in your post! Questions!

    * Are you converting your 401k into a Roth IRA?
    * Or are you converting an IRA where you’ve been contributing ~$5,000 pre-tax into a Roth IRA and therefore never paying taxes on the way in AND on the way out? IF that is that case, then that is magic and not sure how this is possible. I’ve got to re-read your post.
    * If you contribute to an IRA, that means your income had to have been below a certain low income threshold in the first place ~$70,000 or something right? So if there is a tax free conversion, that’s great, but it’s not a massive savings ~20% marginal tax bracket or less?
    * When you put a number in (), the meaning is negative fyi. So Income ($32,000) means you have negative income. but I think you mean you have positive $32,000 in income right? Putting $27,000 in adjustments in () is right as it is a deduction. Maybe this is where I’m most confused.
    * A $4,000 federal tax liability is amazing. But what is Mrs paying in federal tax liability so we can see the whole picture? No matter how hard I try, I can’t legally get down to those levels.

    Thanks for the clarification!

    Sam

    • retirebyforty April 6, 2016, 12:15 pm

      Okay, I will try to clarify in the post as well.
      I am converting my traditional IRA into a Roth IRA. The traditional IRA only has pre-tax money in it. I rolled it over from my pre-tax 401k when I left my job.
      Here is the history
      1. 401k contributed max every year. Pre-tax money.
      2. Convert 401k to traditional IRA.
      3. Convert traditional IRA to Roth.
      I just fix the (). Sorry for the confusion.

      If I put Mrs. RB40’s income back in and remove the conversion, we’d pay about $7,000. Our tax rate is quite low and not much more than what I had to pay in SE tax. There is some kind of weird interplay here.

      • Sam April 8, 2016, 7:54 am

        Gotcha! Thanks for the clarification. So your wife only pays about $3,000 a year in federal income taxes? That is pretty amazing man!

  • Peter April 6, 2016, 10:11 am

    This awesome! Thanks for this.

    Can you please explain how did you get -16000 for rentals? Thanks!

    • retirebyforty April 6, 2016, 10:33 am

      We have 3 units and they add up. The negative comes mostly from depreciation and interest paid.

  • Joe April 6, 2016, 10:04 am

    Great information. Does anyone know how to perform a backdoor Roth IRA? I am maxed out on my company 401k and exceed the income limits for a traditional deductible IRA. I have started to learn about how a backdoor Roth IRA can be done by opening an IRA with after tax dollars and then converting to a (backdoor Roth IRA). I am unclear how to take into consideration any existing rollover IRAs that may exist from prior companies.

    • retirebyforty April 6, 2016, 10:32 am

      I would open a new traditional IRA. I don’t think you need to take the existing IRAs into account as long as they are in a different account. If you plan to invest in mutual funds, I would call Vanguard. They are very good about answering these kind of questions. They have brokerage service too.
      *Okay, I’m wrong about this. I guess you have to take all existing IRAs into account. See comments below.

      • Joe April 6, 2016, 10:40 am

        Thanks for your comments. Fidelity told me I had to take the existing IRAs into account. It says the IRS looks at one’s total holdings regardless of where the IRAs are held. As I started to do more digging, it seems there is some kind of formula to use. I have my tax accountant looking into but wanted to throw it out here as there is so much wisdom on this site.

        • Ndy April 6, 2016, 11:10 am

          Joe, what Fidelity told you is correct. You must take into account your other existing IRAs including roll-over IRAs. Generally speaking, it’s much better to do Backdoor Roth IRAs when you don’t have any other existing traditional IRAs otherwise you would have to pay hefty tax on those too. I’ve been doing Backdoor Roth IRAs for the past 2 years and it’s very clean process when you don’t have any existing traditional IRA. You just have to remember to file Form 8606 when you file your taxes. Goodluck

          • Joe April 6, 2016, 12:10 pm

            Thanks for the follow up.. I created two (2014 and 2015 tax years last April) before I knew about having to take into consideration existing IRAs. I will get it straightened out this year. Hopefully, the tax payments/penalties won’t be too much.

        • retirebyforty April 6, 2016, 11:16 am

          Ok, I see what you are talking about. Thanks for the info from Fidelity.
          This applies when you have tax-deferred and already taxed money in your IRA. When you do a rollover, you have to do it in ratio.
          So if you have $100,000 that is tax-deferred and you add $100,000 with after-taxed money. When you rollover the $100,000, you would have to pay tax on 50% of the amount rollover. Your tax accountant is the best person to look at your situation.
          All the money in my IRA is tax-deferred so I have to pay 100% tax on conversion.

  • Eric Bowlin April 6, 2016, 9:58 am

    Very interesting strategy. I love any way that keeps the taxes down to the minimum!

  • Physician On FIRE April 6, 2016, 9:51 am

    I like to play around with Taxcaster, forecasting different early retirement income scenarios, seeing how small changes in different places affect the total tax. There are a number of variables that make the particular phase-in and phase-outs highly individual.

    Your marital status, children under 17, type of income and how much… just a few of the variables. It’s important to ensure you’re not leaving money on the table by foregoing moves that you could make without affecting your total tax. Roth conversions are a great one. Tax gain harvesting is another, although less powerful than free Roth conversions.

    I’d say your plan is the best way to access your 401(k) / IRA money if your income is low enough to able to make those conversions. Another way, if you’re not in position to do those Roth conversions and don’t want to wait 5 years is to set up Substantially Equal Periodic Payments from the IRA. Not very flexible, but another way to access the funds prior to age 59.5 without penalty.

    Cheers!
    -PoF

  • The Green Swan April 6, 2016, 8:37 am

    Wow, that is a great strategy! You definitely blew my mind! I will definitely have to look into this to see how I can replicate it. I’m not quite to this point in life so I have some time yet, and who knows, tax law could be amended before I’m ready to take advantage of it in 10 years or so.

    Part of my plan is to start a Roth IRA ladder with conversions from my employer sponsored 401k plan. But how I’ll survive for 5 years will be primarily through my taxable brokerage account. What’s nice about your situation is the large loss you are able to record from the real estate property (presumably depreciation and interest?) which brings down your taxable income, so that might be worth exploring for me.

    Thanks for the great post, Joe!

    The Green Swan

    • retirebyforty April 6, 2016, 10:28 am

      I hope the Roth code won’t be amended… The rental properties don’t look great in paper, but they are a great long term investment. Great tax write off too. Thanks for the encouragement.

      • Lisa April 6, 2016, 6:19 pm

        The tax benefits from rental are great — yes — in the short term, but please know what happens if/when you sell the property. All that depreciation is recaptured and your accumulated depreciation deducations are taxed at the 25% rate. Be sure and save some of the tax money to pay that — you’ve already accumulated a future $4k tax bill ($16,000 * 25%) for the future.

        https://www.washingtonpost.com/realestate/readers-plan-to-sell-investment-property-has-major-tax-implications/2014/04/09/37b80e6e-bf2b-11e3-bcec-b71ee10e9bc3_story.html

        • retirebyforty April 6, 2016, 9:57 pm

          Yes, that’s true. Hopefully the proceed from selling the rental will be able to cover that tax bill.
          Anyway, it’s better to defer the tax now, right?
          Also, there is a way around depreciation recapture. If the rental is part of your estate, the inheritor will start over with depreciation at FMV. Sounds like a good way to leave a little something for the kid. Of course, hopefully this will be far off in the future.

  • Dividend Growth Investor April 6, 2016, 8:12 am

    Hi Joe,

    Thank you for outlining the steps you are taking to minimize your taxes going forward. It is funny how the tax code is set up in a way that encourages retirement and investing, and discourages work income.

    If you can Rothify most of your assets, and pay minimal if any tax in the conversion process, you will life a tax-free lifestyle in retirement. The nice thing is that you were likely in a high tax bracket during your working years, but when you do your ladder you will be in a low tax bracket. Therefore, you would have huge savings upfront, tax deferred compounding, and pay minimal (if any) taxes on a go forward basis.

    • retirebyforty April 6, 2016, 10:19 am

      It’s pretty amazing to defer tax and then pay little to no tax on that amount. I never knew it was possible. I thought you always had to pay some tax. Self employment + rental properties + Roth is a very powerful combination.

      • Mr. Tako @ Mr. Tako Escapes April 7, 2016, 2:51 pm

        Hi Joe. Do you have any backup plan if this tax loop hole gets closed? Take the 10% penalty? I wouldn’t be surprised if this kind of tax trick gets closed eventually.

        We’re planning on trying this trick ourselves, but we’re not banking our early retirement on it lasting forever! Primarily we look to cover expenses from dividends.

        • retirebyforty April 8, 2016, 7:37 am

          Yes, I would stop contributing to my i401k and just use that money to fund our cost of living. Or else work part time on something I enjoy. We could draw down our dividend portfolio as well, but I would like to wait until we’re at least 50 to do that.

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