Reduce Your Taxable Income by Contributing More to Your IRA

As April 15th approaches, real estate investors, as most Americans, will come to a universal conclusion: We pay too much in taxes.

Real estate investors can reduce their taxable income by taking advantage of government sponsored retirement plans for self-employed individuals. Once established, these plans become similar to Traditional IRAs, yet they allow individuals to contribute considerably more than $2,000.

You can contribute more than $2,000 to an IRA

Speaking across the country to thousands of real estate investors each year, we always love hearing how excited these investors become when they learn that they are able to combine their present investment strategies, (lease options, rehabs, foreclosures, rentals, raw land, notes etc.) with the incredible forces that IRAs offer.

They love the fact that they are able to choose how and where to invest their retirement savings in the ways they already know and understand. What really astounds them is the realization of how much faster their money is able to compound without the eroding factor of taxes.

One of the most frequently asked questions we hear is: “Is there any way that can I contribute more than $2,000 to into a truly self-directed IRA?” Our first response is: “How much would you like to put into an IRA this year? $5,000, $10,000, 20,000?”

These are all possible options. At this point, they usually perk up and ask, “How is that possible? I have never heard of that before.” This response is not unusual since most IRA Custodians don’t bother spending the time to explain the merits of both the SIMPLE and the SEP IRA.




Maximum Total


15% Up To


$25,500 (2000)


3% Match
Up To $6,500

Up To $6,500


Real estate investors should realize that they are eligible to take full advantage of small business retirement plans created by the government.

These plans are as easy to create as Traditional or Roth IRAs. No matter what hat you wear, be it a sole proprietor, partner, owner of an incorporated or unincorporated business, consultant or independent contractor, you are eligible for either a SIMPLE or an SEP IRA. The only question is, which plan is right for you?

Which plan is best for you?

Now that we have established even a single real estate investor qualifies for either of these plans, let’s discuss the basic characteristics, so that you can determine which one is right for you.

When we speak of annual compensation, we are generally referring to total wages for employees or earned income for those self employed. If you receive only rental income (passive income), you will need to pay yourself a salary (earned income) for managing your properties.

In many instances real estate investors will wear two hats as it pertain to SEP and SIMPLE retirement plans: those of employee and employer.

In this case, both contributions (employer & employee) go directly to the investor’s IRA! Also keep in mind that in addition to these plans, real estate investors can have an Individual IRA (Traditional or Roth)..

The SIMPLE IRA (Savings Incentive Match Plan for Employees)

* Business Eligibility: Generally, small businesses (again this includes self employed individuals, including sole proprietors, partnerships and corporations) that employ 100 or fewer employees are eligible.

* Employee Eligibility: The employee must have earned at least $5,000 in the preceding year and reasonably expect to earn at least $5,000 for the current year. These requirements are the maximum and can be reduced by the employer.

* Employee Contributions: Employees can contribute 100% of their annual compensation up to $6,500 a year.

* Employer Contributions: Employers match dollar for dollar up to 1 , 2, or 3% of the employee’s annual compensation (max. $6,500 indexed). The employer is only responsible for employees who have contributed.

* Deductions: Employees may deduct their contributions from personal taxable income, while the employer may deduct the matching amount from the business’ taxable income. If you are self-employed, you receive both of these deductions!

We often recommend that investors who receive less than $50,000 in annual compensation should choose the SIMPLE. This will allow them to contribute the maximum amount to their IRA.

Another favorable point about this plan is that if you have employees, other than your family, you as the employer are only responsible to match if the employee contributes funds first. In addition to these benefits, after two years you may be able to convert your SIMPLE IRA to a Roth!

The SEP IRA (Simplified Employee Pension Plan)

* Business Eligibility: Any employer, whether a corporation, partnership, or self employed individual, may establish the plan, even if there is only one employee.

* Employee Eligibility: Employees must be 21 years of age, worked for your business during any three of the past five years, and earned the yearly minimum required compensation ($450 for 2000 adjusted annually).

* Employer Contribution: Each year an employer may contribute up to 15% (approximately 13% for those self-employed) of each eligible employee’s annual compensation (max. $25,500). The employer does not have to contribute each year.

* Deductions: Employers may deduct every qualified dollar they contribute from their taxable income!

The SEP allows an individual to contribute the most to an IRA (up to $25,500). Remember, an employer must contribute the same percentage for all eligible employees. However, an employer may choose each year whether to contribute to this plan and is under no requirement to offer it each year.

Supercharge your Roth IRA

One feature of both the SIMPLE and SEP IRA that most investors are not aware of is this: Contributions made to both of these IRAs can be converted to a Roth IRA! Imagine being able to enjoy the contribution limits of a SIMPLE or SEP IRA and the tax-free status of a Roth IRA.

It must be noted that a SEP IRA can be immediately converted while a SIMPLE IRA must wait two years from the date of the first contribution to be eligible for a Roth conversion.

Remember that when you make a Roth conversion this is a taxable event. The amount you decide to convert will be added to your annual income for that year. But don’t forget you will receive a deduction for contributions to a SEP or SIMPLE IRA, making the conversion practically a wash!

How these plans can work for a real estate investor

A SIMPLE Example: John Smith and his wife each earn $20,000 a year from their real estate business where they are the only employees. The Smiths believe they pay too much in taxes, and they would like to reduce their taxable income as well as contribute the maximum to an IRA.

They plan to make real estate investments similar to those of their business, while compounding their profits tax-deferred. In order to optimize their IRA contributions, they both decide to open a Traditional and SIMPLE IRA.

By each contributing $2,000 to their Traditional IRAs, the Smiths are able to deduct $4,000 from their taxable income. They then contribute $6,000 each to their SIMPLE IRAs as employees of their real estate company.

As employers they have decided that they will match 3% of each employees annual compensation ($20,000 X 3% = $600 each.

In this instance the Smiths must wear two hats, one as employee and the other as employer. Because of their participation in these two IRAs, the Smiths have been able to:

  • Contribute $17,200 ($4,000 + $12000 + $1200) to their IRAs this year, which can be used to invest in real estate.

  • Lower their taxable income from $40,000 to $22,800!

A SEP Example:

Mrs. Jones owns her own mortgage company and earns $100,000 per year in W-2 income. She is the only eligible employee. Mrs. Jones agrees with the Smiths and feels that she is paying excessive amounts in tax each year.

While she has heard from Mr. and Mrs. Smith how good a SIMPLE plan is, she realizes that the SEP plan would be even better for her.

With the SEP, Mrs. Jones, as the employer, has chosen to contribute 15% of her salary. Instead of the $6,000 contribution limit for the SIMPLE plan, Mrs. Jones will be able to contribute $15,000 to her SEP.

With the $2,000 she has contributed to her Roth IRA, she has now been able to contribute $17,000 to her IRAs and reduce her company’s taxable income by $15,000!

As with the SIMPLE plan it should be noted that if Mrs. Jones has a husband and children, they may participate in the SEP plan and enjoy all the benefits she will as long as they are employees of the company.

Once the plans have been established, a SIMPLE and SEP IRA follow the same guidelines as a Traditional IRA. The only exception is that a SIMPLE IRA must stay as a SIMPLE for two years before it can be converted to a Roth IRA.

As in any self-directed IRA, investors have the option of using funds from their SIMPLE or SEP IRA to invest in all forms of real estate and notes, as well as any other IRS approved investments. So start enjoying the benefits of tax-deferred, compounded growth today!

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