I think that owning the real estate outright instead of having it owned by a traditional IRA is a better choice. Expenses offset the income at your marginal tax bracket and there are favorable tax rates on capital gains when the property is disposed of. Even if the rental income is not sufficient to cover all of the expenses, you still benefit. Any passive loss carryovers attributable to the rental are deducted in the year of sale at your highest marginal rate bracket while the gain on the property has lower rates.

As you’ve determined the decision is less clear cut when you are comparing the purchase to Roth IRA ownership. With the Roth – I do think it’s tax free forever but you must be careful to not do anything to cause the IRA to be disqualified or enter into a prohibited transaction. You’re planning on using a property manager – that’s a good way to avoid prohibited transactions. I’m presuming that the property manager is independent and not a relative. The tenant of the property should also be unrelated. Some of the tricky items occur when let’s say you pay a property tax installment personally because you can’t reach the manager or there’s not enough cash available. Paying an expense of the Roth is a prohibited transaction. You can probably imagine other innocent activities that might occur in the operation of a rental by the owner even if there is a manager. That’s a risk that you can’t quantify readily.

What if the property goes down in value? You can deduct a loss from the sale of a rental property on your personal return in full – no $3,000 per year limitation. If the Roth (or a traditional IRA) has a loss on the sale of a rental property – it’s just less wealth for you or your beneficiiaries.

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