Planning Your Legacy: Structuring Real Estate Investments for a Smooth Transition

You've spent years building a rental property portfolio that generates passive income and long-term wealth. But have you considered what happens to those assets when you're gone?

For real estate investors, estate planning isn't just about writing a will—it's about structuring your investments to minimize tax burdens and ensure your beneficiaries inherit the full value of what you've built.

The decisions you make today determine whether your heirs receive a wealth-building machine or a complicated tax problem. Let's examine three common structures investors use and how each impacts your legacy.

Structure #1: Traditional Self-Directed IRA

When you hold rental properties in a Traditional SDIRA, you receive tax deductions on contributions today, and rental income grows tax-deferred. This provides immediate tax relief, allowing your investments to compound without annual tax drag.

However, your beneficiaries will owe income taxes on every dollar they withdraw.

Here's where estate planning gets tricky: if your beneficiaries inherit during their peak earning years, those distributions could push them into higher tax brackets. That can be a problem.

Imagine your daughter inheriting rental properties in a Traditional SDIRA while she's in her 40s, earning a solid salary. The rental income from your properties becomes taxable income stacked on top of her existing earnings. What you built as a wealth-generation tool could turn into a significant tax liability for the people you're trying to help.

Structure #2: Roth Self-Directed IRA

A Roth SDIRA takes the opposite approach. You pay taxes on contributions now, but qualified distributions—including those your beneficiaries take—are completely tax-free. This structure can preserve significantly more wealth for heirs who will likely be in higher tax brackets when they inherit.

Consider this: converting properties from a Traditional to a Roth SDIRA triggers immediate taxes for you, but it might be worth it if you're currently in the 22% bracket and your beneficiaries will likely be in the 32% bracket when they inherit. You're essentially prepaying taxes at today's rates to save your heirs from tomorrow's potentially higher rates.

The upfront cost may sting, but the long-term benefit to your beneficiaries can be substantial—especially when rental income and property appreciation compound tax-free for years before being transferred.

Understanding the 10-Year Rule

Whether you choose a Traditional or Roth account, there's a critical timeline that your beneficiaries must understand: the 10-year rule.

The SECURE Act of 2019 fundamentally changed how beneficiaries inherit retirement accounts. Previously, non-spouse beneficiaries could "stretch" distributions across their lifetime, allowing inherited assets to continue growing tax-deferred for decades. Those days are over.

Now, most non-spouse beneficiaries must empty inherited retirement accounts—including Self-Directed IRAs holding real estate—within 10 years of the account holder's death. This creates unique challenges when your SDIRA holds rental properties rather than liquid stocks and bonds.

Your beneficiaries will need to either sell the properties and distribute the cash, take in-kind distributions (transferring properties out of the IRA), or use a combination of both strategies. With a Traditional SDIRA, each distribution triggers taxes. With a Roth SDIRA, those same distributions come out tax-free.

The 10-year clock starts ticking the moment you pass, regardless of your beneficiaries' readiness or the real estate market conditions. This is why the Roth structure often proves more flexible—your heirs can strategically time distributions based on their financial situation rather than tax consequences.

Structure #3: Direct Ownership Through LLCs and Trusts

Of course, not all investors hold real estate in retirement accounts. Properties owned directly, often through LLCs for liability protection, face different estate planning considerations.

A single-member LLC provides liability protection during your lifetime but doesn't avoid probate. When you pass, that LLC and its properties must go through probate in each state where you own real estate.

For investors with properties across REI Nation's 11 markets, that could mean multiple probate proceedings—each with its own timeline, costs, and legal requirements.

A revocable living trust offers a solution. Properties held in trust bypass probate entirely, allowing your successor trustee to immediately manage or distribute assets according to your wishes. You maintain complete control during your lifetime, but upon your death, the transition is seamless.

Many sophisticated investors employ a hybrid approach, holding properties in LLCs (for liability protection) that are owned by a trust (for probate avoidance). This combines the best of both worlds—protecting your assets during your lifetime while ensuring a smooth transfer to your heirs.

Making the “Right” Choice for Your Portfolio

No single structure works for everyone. Your decision should consider:

• Your current tax bracket versus your beneficiaries' expected brackets
• The timeline for when you expect assets to transfer
• Your liquidity needs during retirement
• The complexity of your portfolio across multiple markets
• Your beneficiaries' ability to manage real estate assets

Further Reading: You Achieved Early Retirement…Now What?

Building a real estate portfolio takes decades of strategic decisions. Preserving that wealth for the next generation requires the same intentional planning. Start by evaluating your current structure, then consult with professionals who specialize in real estate investor estate planning.

Finally, communicate with your beneficiaries. They should understand what they're inheriting and the decisions they'll face. The structure you choose today determines whether you're simply passing down properties—or passing down true generational wealth.

Ready to discuss how your REI Nation portfolio fits into your estate planning strategy? Connect with your portfolio advisor today.