Roth Conversion Strategy for IRA Real Estate: Don’t Leave a Tax Bomb

“I bought a property cheap in my traditional self-directed IRA. If I move it to my Roth, am I taxed on what I paid?”

A Roth conversion of real estate held in your IRA raises two questions: what you’re taxed on, and how to do it without one huge tax bill. In our September live Q&A, Laura Dohanes, CPA, answered the first, and guest John Bowens of Equity Trust Company laid out a staged plan for a paid-off house in a SEP IRA.

Quick answer: No. A Roth conversion is taxed on the property’s fair market value when you convert, not what you paid. For a paid-off house in a SEP IRA, John’s approach: if you qualify for a SEP you probably qualify for a Solo 401(k); roll the property in and convert it to Roth in slices over several years, which is simple bookkeeping inside the plan. It matters because a large traditional IRA can land on your kids as a tax bomb.

Taxed on what you paid? No, on fair market value

Laura’s quick answer: a conversion is taxed on the fair market value at the time you convert. If the property has gone up since your IRA bought it cheap, you pay tax on today’s value, which is why the annual valuation your custodian reports matters so much. Not the fun answer, but an important one.

A SEP IRA that owns a paid-off house

The second question: “My SEP IRA owns a paid-off house. How can my kids inherit it without a huge tax bill? The stretch IRA looks bad now.” It does. The old “stretch” is mostly gone. Since 2020, most non-spouse heirs must empty an inherited IRA within 10 years.

Roth conversion of real estate in slices

John’s starting point: if you qualify for a SEP IRA, you probably qualify for a Solo 401(k). Roll the property from the SEP IRA into the Solo 401(k), then convert it to Roth in stages. Say the property is worth $200,000: convert about $25,000 of value a year for eight years. Each year’s slice is taxed on the property’s value that year, so plan on an appraisal for every year you convert. Spreading it out keeps each year’s conversion income (and the bracket it lands in) under control.

Why the Solo 401(k) makes it simple

Inside a Solo 401(k) with a Roth option, staged conversions are just recordkeeping in the plan’s software (the plan must allow in-plan Roth conversions). You don’t have to re-deed a percentage of the property to a Roth IRA every year. And if you later want to borrow to buy another property, the Solo 401(k) is generally exempt from the UDFI tax an IRA would owe on real estate debt, if the loan meets the code’s conditions.

What you leave your kids: tax-free money or a tax bomb

Once the property is fully on the Roth side, growth and qualified distributions are tax-free. Your kids or grandkids still have to take it out within 10 years, but they pay no tax when they do. Compare that with leaving $1 million in a traditional IRA or pre-tax 401(k): your heirs have to pull it out within 10 years, often in their highest-earning years, and pay tax at their top bracket. John’s theory is that Congress did that math when it passed the 10-year rule. Converting in stages trades your tax now, at rates you can plan, for tax-free money later.

Official IRS reference: IRS — Rollovers of Retirement Plan and IRA Distributions

Key takeaways

• A Roth conversion is taxed on fair market value at conversion, not your purchase price.
• Most non-spouse heirs must empty an inherited IRA within 10 years; the stretch is mostly gone.
• If you qualify for a SEP IRA, you likely qualify for a Solo 401(k).
• Converting a property in yearly slices spreads the tax; a Solo 401(k) makes it simple bookkeeping.
• An inherited traditional IRA can hit heirs in peak-earning years; a Roth reaches them tax-free.

Roth conversion of real estate FAQs

Related questions from this Q&A

• The full September self-directed IRA Q&A with John Bowens: every question on one page
• Inherited IRA real estate: what happens when you die
• The Roth 5-year rule explained

Want answers to your own tax questions live?

These answers come from our monthly open Q&A. Only newsletter members get the invite (real tax strategy for business owners, twice a week, no fluff).

Join the newsletter →

Want Laura to look at your situation? Book a free strategy call →

Guest: John Bowens, Director & Head of Education and Investor Success at Equity Trust Company, appeared as a guest. Custodians, including Equity Trust Company, do not provide tax, legal or investment advice.

Disclaimer: This article is for educational purposes only and is not tax, legal, or financial advice. Every situation is different. Talk to a qualified professional about your specific facts before making any decisions.