If you're renting a property, you may be thinking of sheltering that income in a Roth individual retirement account. While you don't get a deduction for contributions to a Roth, your investment will grow tax free, and assuming you don't take distributions until age 59 1/2 and hold onto your Roth for at least five years, you won't pay tax on your distributions. Unfortunately, rental income, per se, probably can't be socked away in an IRA.
You Have to Earn It
What is now known as the traditional IRA was created for people who did not have retirement plans at work. Eventually, they were expanded to those who already had retirement plans, and the Roth IRA was created for those who expected to pay higher taxes after retirement than during their working years, in other words, those with more assets. However, the IRS kept some rules that keep IRAs from being a tax shelter for the wealthy: Annual contribution limits remain relatively modest -- $5,500 for those under 50 at the time of publication; contribution limits for Roths diminish progressively down to zero when your modified adjusted gross income reaches certain thresholds; and contributions must come from earned income -- not interest or dividends from investments or passive income, such as rental payments.
Self-Employment Income Counts
Self-employment income does count as earned income. Tax adviser George Saenz, answering questions for Tax Talk on Bankrate, suggests that a way around the earned income dilemma is to set up a property management company in which your salary is paid from the rental income. Of course, this involves the expenses of incorporating, and your salary would be subject to federal -- plus possibly state -- and Social Security withholding. Because you can't contribute more than you make, you'd want to make considerably more than $5,500 a year in rentals for this to be worthwhile. But you wouldn't want a modified adjusted gross income of more than $190,000 if you're married filing jointly, or $128,000 if you're single, because those are the incomes past which you can't contribute to a Roth at the time of publication. Check with the IRS for current limits.
If you work even a part-time job with a small income or make money as a sole proprietor, you can put your qualified income, up to the annual maximum limits, into an IRA. So if you make $5,500 per year, you can contribute that much to your Roth. If you make only $3,500 per year, then that's your annual limit. Obviously, if that's your only income, it isn't likely you would put it all into a Roth IRA, but the IRS doesn't know or care about that. In other words, if your rental income is really what you live on, you can contribute from it to your IRA as long as you make at least that much from your employment. However, for sole proprietor income to count, you must be engaged in work with a profit motive.
It Takes Two
If you're single with only rental income, a spousal Roth IRA may be one reason to consider tying the knot. As long as your spouse makes enough to cover both your and his contributions -- but not over the limit for couples filing jointly -- your spouse can make a full or limited contribution to an IRA on your behalf. For all intents and purposes, that money could be your rental income.
Nancy Cross is a certified paralegal who has worked as an employee benefits specialist and counseled employees on retirement preparation, including financial and estate planning. In addition to writing and editing, she runs a small business with her husband and is a certified personal trainer with the Aerobics and Fitness Association of America (AFAA).