Never ever put a tax shelter investment inside another tax shelter. 

What many people don’t realize is that this is exactly what they are doing when they invest in rental real estate through their retirement plan (like an IRA).

I’ll use the IRA – a popular retirement plan in the U.S. – as an example here, but the approach and concept can be applied to retirement plans in other countries as well.

An IRA is a tax shelter. Tax on the income is either deferred (Traditional IRA) or eliminated (Roth IRA).

Rental real estate is an example of a type of real estate investment that can be a tax shelter on its own. Rental real estate often generates losses for tax purposes even when there is positive cash flow. This is because of the depreciation deduction that can be taken on the investment.

When properly executed, rental losses can be used to offset other income which effectively shelters that other income from income tax. This can result in significant tax savings.

If an IRA has rental losses, the IRA is generally not paying tax so there is no tax to shelter.

If an individual has rental losses, there is an opportunity to shelter other income, including W-2 or business income, from income tax. This results in not paying tax on that other income and those tax savings mean cash in your pocket.

Run the Numbers
As with many wealth and tax questions, the answer can be found by running the numbers. Are there more tax benefits available to you if you invest in rental real estate inside or outside of your retirement plan? Run the numbers based on your long term wealth strategy.

In the analysis I’ve done with clients and for myself, the tax results are better when a tax shelter (rental real estate) is not put inside another tax shelter (a retirement plan). The tax benefits lost are too significant.