How To: Get Tax Free Rental Income 

Financial Planning Dentist

Let’s paint a picture of what that world might look like if you could successfully put a rental property into a Roth account. With a Roth, growth in the value of the assets is tax free and the income that comes from your rental is tax free. You may have heard of people buying real estate in self-directed IRAs, and while the income and growth is tax deferred, when withdrawn, creates ordinary income. So, imagine if you could get all that growth tax free in a home in Colorado, while also receiving tax free income after the age of 59.5 every month. Seems like a win win to us and our clients love it. 

There are four major benefits to this strategy. First, implementing this strategy can lower your effective tax rate by reducing the withdrawal rates from your tax deferred accounts. Since the first dollars you get in retirement can be from your Roth distributions, this will lower your effective tax rate on other incomes like capital gains on taxable assets, distributions from Traditional IRAs, tax deferred annuities, Pensions, 403(b)s, or 401(k).

The second additional effect of this strategy is that Roth’s don’t require that you take a Required Minimum Distribution. So there is no need to liquidate the asset at any point during retirement unless you want to. It’s a near permanent way to get rental income throughout the duration of your retirement. 

The third less used benefit, is that some income from the property can also be used to buy other income generating assets to help diversify the stream of income and supply you with less income risk in your non-working years. 

The fourth benefit is when you pass the assets onto your heirs.  With the Tax Cuts and Jobs Act, inherited IRAs lost a key feature which previously enabled beneficiaries to prolong taking distributions from inherited IRAs over their own life expectancy or the life expectancy of the deceased, and requiring them to take it out over 10 years. This forces beneficiaries that may have an unfavorable tax situation into an even more unfavorable tax liability as they’re forced to take on ordinary income from these accounts. However, with Roth accounts, although there are Required Minimum Distributions for inheriting a Roth, the distributions are tax free which is a huge benefit to the beneficiaries. There are some exceptions to this rule but generally speaking, inheriting Roth Accounts for most people is better than inheriting IRAs. 

We think this is a near permanent endowment of tax free income, with the ability to rise with inflation, through the entirety of your retirement. I have a perfect storm of desired qualities for most investors.

There are however, a few challenges to accomplishing this task, and it depends on the amount of money available in your Roth currently. Because of income and contribution limits to Roth’s most people will not amass the required liquidity in their Roth to be able to make the down payment on a piece of real estate, fewer still will have the assets to be able to buy the property outright. 

There are four techniques that we employ this strategy which you should become familiar with. 

  • Backdoor Roth Contributions, or a Mega Backdoor Roth
  • Self Directed Roth’s
  • Asset Lending in Self Directed Roth’s
  • Non traded REIT’s

Backdoor Roth Contributions, or a Mega Backdoor Roth jumpstart Tax Free Rental Income 

Getting the requisite assets into a Roth can be a bit of a trick. The income limits keep most affluent earners from being able to contribute at all. Even if your income makes you eligible for such a contribution, the annual limit of $6,000 for those younger than 50, means saving and investing for a lifetime into your Roth would scarcely get to an amount meaningful enough to make a down payment or to buy a meaningful property outright (depending on your local market).

So getting the investment assets into the account becomes job one. A few ways to jump start this process is to convert assets from your IRA. Generally investors have far more money in Traditional IRA’s and 401k’s then they do in their Roth. Now a quick off ramp to the “tax free rental income” plan would be simply tax deferred rental income by using the assets in the qualified accounts. But for those who want the full boar strategy they need to get ambitious about getting money into you Roth. 

We discuss details of the Backdoor Roth Contributions at length here, and the Mega Backdoor Roth here. Both of these methods can provide ample accelerant to getting money out of the qualified account and into the Roth account expeditiously. 

There is also a simple conversion of assets for those who are willing to pay taxes currently, to avoid them in the long run. You should work with your CFP® professional or CPA to determine if this tax strategy is the right fit for you. 

Self Directed Roth’s are key to Tax Free Rental Income 

Most investors are familiar with IRA’s and Roth’s and many are familiar with Self directed accounts (SDIRA). You can see the definition here if you are not yet familiar with SDRIA’s and Roths. We use these specialty account types to properly custodian the assets and make sure they stay compliant for use as an essential part of the “tax free rental income” strategy.

These account types delimit the investment types that can be held and make owning a single real estate property (as opposed to traded REIT’s) possible. They provide the right type of tax treatment for assets we like to use. There are however, several compliance and custodian issues that you should be aware of to prevent the asset from being declassified as either an IRA or Roth asset. Oversight of these rules and administration of the accounts is something best overseen by a CFP® professional who understands your situation and can help you stay compliant at all times. 

Asset Borrowing in Self Directed Roth’s

There are several things you should know about when it comes to borrowing in a self-directed IRA, or any IRA for that matter. You can familiarize yourself with those elements here, but you should definitely consult a CFP® Professional to make sure that it makes sense for you.

Borrowing in your SDIRA, just like a mortgage, can help shortcut the gap to owning a property by allowing you to use your assets as the down payment and borrow the rest. The use of leverage can be a positive in terms of asset growth, or negative if borrowing rates are too high or rental income is too low. You should have a CFP® professional and a property management company review these conditions in coordination to make sure the investment is sound.

Non traded REIT’s

Using a non traded REIT’s can have advantages and disadvantages for real estate investors. You should be familiar with them and their liquidity restrictions before you use them. Some of the upsides are that the cost for entry into these REIT’s can be lower than owning the entirety of the rental property by yourself, allowing you to own an income stake in several different properties for the same amount of capital. This strategy allows you to lower the overall risk, but also limits a degree of control over the asset and less liquidity. This can be a fantastic compromise for the investor who wants the “tax free income strategy” but not the daily rigor involved with managing a property.

Owning a stake in a non traded REIT can also be a more diversified approach to several different classes and types of real estate that may provide different types of income and a more steady cash flow. You should be familiar with the REIT’s management, track record, and financial solvency before participating in a non traded REIT. 


Getting to a place where you’re collecting tax free rental income might seem like a journey, but the outcome is an incredibly valuable way to make sure you’re generating a steady and increasing income into and through retirement. There is not a more desired outcome for most investors than stable flow of tax free rental income and the potential for tax free capital appreciation from a single strategy. Working with your CFP® professional and investment advisors to make sure this is the right outcome for your plan, and confirming the investments stay compliant is a small price to pay for such a robust answer to the question of income in retirement.

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Boulder Colorado Financial Planning
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