24 Mar Can I invest profits from a home sale in an IRA?

Q. We are retired and our income is such that we do not pay federal or state taxes, and we will soon have proceeds from a home sale. We both have a traditional IRA and have been advised by our fund manager to invest in them and also the money from the home. If we consider a Roth IRA and invest what could be about $250,000, how much tax will we have to pay?
— Seller

A. Let’s begin with some good news about the sale of your home.

You probably won’t owe any federal or New Jersey income tax on its sale, assuming that you’re married and that you and your spouse file a joint income tax return.

Provided that you and your spouse have owned your home and also used it as your principal residence for at least two out of the last five years, ending on the sale date, you can exclude up to $500,000 of capital gain from the sale, said Gene McGovern, a certified financial planner with McGovern Financial Advisors in Westfield.

He said you also must not have excluded gain from the sale of another home during the two-year period ending on the sale date.

As for making an IRA contribution, for 2020 and later years, there’s no age limit on making contributions to a traditional, deductible IRA or to a Roth IRA, he said. For 2019 and earlier years, the limit for traditional IRA contributions was age 70 ½, but there was no age limit for Roth IRA contributions.

For 2019 or 2020, the total contribution for each of you to either type of IRA account can’t exceed $6,000, or $7,000 if you’re age 50 or older, McGovern said.

“However, to make an IRA contribution of either type, you must have earned income, such as wages, tips, salary, or income from a business you own,” he said. “Pensions, Social Security benefits, gains from the sale of your home, or interest and dividends don’t count as earned income.”

If your earned income is less than $6,000, your IRA contribution is limited to the smaller amount, he said.

A special rule applies for non-working spouses. A non-working spouse can still make an IRA contribution up to the maximum limits as long as the working spouse has enough earned income to cover both contributions, he said.

“Since you and your spouse are retired and not paying federal or state income taxes, it’s likely that an IRA contribution would be limited or unavailable to you,” McGovern said. “At the same time, if you are not currently paying any income taxes, the benefits to you of an IRA, whether traditional or Roth, may be limited or marginal at best.”

On the other hand, once you’ve invested the $250,000 from your home sale, the interest and dividends you earn could potentially raise your income to the point where you begin to owe taxes, he said. In that situation, you might consider converting your traditional IRA accounts to Roth IRAs.

“Any pre-tax IRA contributions that you made, along with the earnings on those contributions, would be taxable when converted to a Roth IRA, but the tax would likely be at the lowest tax rates of 10 percent or 12 percent,” he said. “Conversions can be done over several years to ‘fill up’ the lowest tax bracket.”

Meanwhile, future distributions from the converted Roth IRAs would be tax-free if you follow certain rules, he said.

“If you leave the Roth IRAs to children or other beneficiaries, the money remains tax-free to the beneficiaries,” he said. “You should consult with your tax advisor on whether such a strategy would be beneficial to you.”

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This story was originally published on March 24, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.