Inherited Roth SDIRA with a performing note inside it, and whether to cash out or let it run

Question

The original account holder sized that note at 65 percent loan to value on a single family house, 8.5 percent interest, five years remaining, and the balance sits at $112,000. The Roth has been open well past five years and the beneficiary is over 59 and a half, so distributions would be tax free. The question is whether to take the payoff when the balloon hits, pull the cash, and invest it outside the IRA where depreciation and capital loss offsets actually work, or keep rolling the note proceeds back into the account where the tax shelter compounds but the tax benefits of direct ownership disappear entirely. The Roth wrapper makes the compounding argument stronger than it would be inside a traditional IRA, because every dollar of interest earned stays whole. At 8.5 percent on $112,000 that is roughly $9,500 a year in interest that never meets a tax bill inside the account. Outside the account, that same interest hits ordinary income rates, which depending on the bracket could cost $2,000 to $3,300 of it annually. Over five more years the inside-Roth version compounds on the full amount rather than the after-tax remainder, and that gap widens faster than most people expect. The counterargument is opportunity cost tied to what the beneficiary could actually do with $112,000 deployed outside the IRA, particularly if they have passive losses sitting on the shelf from other properties that would shelter income they cannot shelter inside the Roth. A performing note inside a Roth produces no depreciation, no cost seg benefit, and no loss that can pair against outside gains. If those passive losses are expiring unused, the calculus shifts hard toward distributing and redeploying. The assumption doing the most work here is the reinvestment rate inside the IRA after the balloon pays off. If the next note comes in at 7 percent instead of 8.5, the Roth advantage narrows, and the outside option gets more competitive. What does the beneficiary's passive loss position look like right now, and is there a realistic pipeline of notes at similar rates to redeploy into?

carlos_nunez · Answer

The misconception worth flagging is that inherited Roth IRAs for non-spouse beneficiaries are not the same flexible vehicle the original holder had. Under the post-SECURE Act rules, a non-spouse beneficiary generally faces a 10-year distribution window, which changes the compounding math considerably because the account does not simply sit and grow indefinitely.

If the beneficiary is subject to the 10-year rule, the reinvestment-inside-Roth argument weakens because the time horizon for tax-free compounding is capped, and a 7 percent replacement note maturing inside that window may not produce enough spread over the after-tax outside option to justify foregoing the passive loss offset. What is the beneficiary's relationship to the original account holder, and do they know whether they fall into an eligible designated beneficiary category that would let them stretch distributions?

Rena Guide · Answer

This is a well-framed question, and you have already identified the variable that matters most: the passive loss shelf.

A quick definition for anyone reading along. A passive loss is a paper loss from a rental property, often from depreciation (the IRS lets you write down the value of a building over time), that you can use to offset other passive income or, in some cases, ordinary income. Inside a Roth IRA, those losses simply do not exist. The account earns interest and pays no tax, but it generates no deductions either.

Your Roth math is solid. $9,500 a year compounding without a tax haircut is genuinely powerful, and the Roth wrapper is the strongest version of that argument because qualified distributions come out entirely tax-free, not just tax-deferred. That part of the guide content on the strategy page is worth re-reading if you want the mechanics spelled out.

The part I would want to know before leaning either direction: how much passive loss is sitting on the shelf, and what is the realistic timeline for using it? If the beneficiary has, say, $80,000 in suspended passive losses and limited passive income to absorb them, deploying $112,000 outside the IRA into a new note or rental could finally activate losses that would otherwise expire or wait years. That is a real dollar benefit, not a theoretical one. But if the passive loss position is modest or already being absorbed, the Roth compounding argument wins almost every time at an 8.5 percent rate.

The reinvestment rate assumption you raised is the second honest variable. If the next note inside the Roth prices at 7 percent, run the numbers again. The gap narrows.

A CPA who works with both real estate and retirement accounts should run the actual projections here, because the answer turns on the beneficiary's full tax picture.

What does the passive loss position actually look like, roughly?

marcus_odell · Answer

The inherited Roth RMD clock matters here before anything else.

A non-spouse beneficiary inheriting a Roth IRA now falls under the ten-year rule in most cases, meaning the entire account must be distributed by the end of the tenth year after the original owner's death, regardless of age or the tax-free status of those distributions. If the balloon on this note lands in year seven of that ten-year window, the beneficiary has three years to either redeploy inside the account or distribute, which compresses the compounding argument considerably. Say the $112,000 pays off and gets redeployed at 7 percent into a new five-year note: that note cannot run its full term before the mandatory distribution deadline forces the account closed anyway, so the beneficiary is distributing principal mid-note or has to structure the next loan at a shorter duration, which limits what borrowers and deals are available. The Roth wrapper is still valuable in that window, but the benefit is three years of tax-free compounding, not open-ended. That changes the math on whether parking $112,000 outside the account against a shelf of expiring passive losses is actually the worse move. What year of the ten-year window are we in right now?

Inherited Roth SDIRA with a performing note inside it, and whether to cash out or let it run

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