The Roth Conversion Strategy: Discounted Conversions Using Private Real Estate

What Is a Discounted Roth Conversion?

Under current IRS guidance, a Roth conversion is generally taxed on the fair market value of the asset converted, not its nominal cost. When the asset is an illiquid private real estate interest, fair market value reflects more than the dollars originally put in. A third-party appraisal firm generally documents two well-recognized valuation factors: a discount for lack of marketability, since the interest cannot be readily sold, and a discount for lack of control, since a fractional, minority position has limited say in how the property is run.

Fair market value can also reflect where the underlying project sits in its life cycle. Many private real estate investments are development-stage deals, and an interest may be appraised while the project is still being built out and is not yet generating income. In that pre-revenue state, the appraiser is valuing what exists today, not what the finished, stabilized property may eventually be worth once it is complete and leased up.

Consider an analogy. Imagine buying a house while it's still under construction. The foundation is poured and the framing is up, but the kitchen isn't installed, the floors aren't finished, and the yard is still dirt. An appraiser today values the property based on what's there, not what it will be once the crew finishes and a family moves in. The house ends up being the house. A discounted Roth conversion is generally understood to work the same way. The conversion is generally taxed on the half-built house. The Roth IRA holds the finished home.

Let's look at a hypothetical scenario to see how the mechanic translates into real numbers. Assume a traditional IRA holds a $250,000 limited partnership interest in a private real estate fund. The sponsor's third-party appraisal firm, applying Revenue Ruling 59-60 factors, establishes that the fractional, illiquid LP position is worth approximately $150,000 today, a 40% discount to the nominal $250,000 figure. When the investor converts to a Roth, the conversion is generally taxed on the appraised $150,000, not the $250,000 face value, subject to the sponsor's appraisal being supported under Revenue Ruling 59-60. At a 32% federal marginal rate, that would be a conversion tax of approximately $48,000 instead of $80,000, an illustrative savings of approximately $32,000.

The full $250,000 position still moves into the Roth IRA, where it may potentially continue to grow and eventually distribute tax-free (subject to Roth seasoning and the age 59.5 requirement). The discount applies only at the conversion event. Once inside the Roth, the position behaves like any other Roth balance. Discount magnitudes vary by offering and are established per deal by the sponsor's appraisal firm. This is a simplified hypothetical; actual tax outcomes depend on individual circumstances. Consult a qualified tax professional.

The discounted Roth conversion is not a one-size-fits-all play. It tends to make sense when one or more of the following five situations describe an investor's circumstances. None is a guarantee, and each should be evaluated with a qualified tax advisor.

1. The investor expects future tax rates to be higher than today. Roth conversions trade certain tax now for uncertain tax later. When an investor believes future rates may be higher (because of bracket creep, RMDs forcing income recognition, or federal rate increases), paying tax today at a discounted basis may potentially lock in the lower rate.
2. The investor has liquid capital outside the IRA to pay the conversion tax. The math generally only works when the conversion tax is paid from a savings or brokerage account, not from the IRA itself. Pulling tax dollars out of the IRA shrinks the tax-free position and erodes most of the benefit. Investors who do not have outside capital ready often discuss with their CPA whether to wait until they do.
3. The converted asset has room to grow inside the Roth. Every dollar of growth inside a Roth IRA is generally tax-free under current law. The longer the growth runway between conversion and distribution, the larger the tax-free balance at retirement may potentially become. A growth-oriented private real estate position, held for the full 5-to-7-year hold period, may potentially produce tax-free upside on top of the discount-driven tax savings.
4. The investor wants to reduce mandatory taxable income in retirement. Traditional IRAs trigger Required Minimum Distributions starting at age 73 (under SECURE 2.0, or 75 for those born in 1960 or later). Those distributions push taxable income up, can lift the retiree into higher brackets, and may increase Medicare IRMAA premiums and the taxable portion of Social Security. Roth IRAs are generally not subject to lifetime RMDs. Converting before RMD age may potentially remove that mandatory income stream entirely.
5. The investor is planning a tax-efficient legacy for heirs. When non-spouse heirs inherit a traditional IRA, the SECURE Act generally requires withdrawal of the entire balance within 10 years, with each dollar taxed as ordinary income, often during the heirs' peak earning years. A Roth inherited under the same 10-year rule still requires distribution, but each dollar generally comes out tax-free under current law. The conversion may potentially shift the tax bill from the heirs (at their future rate) to the investor today (at a discounted basis).

The mechanics rest on IRC Section 408, which is generally understood to govern traditional and Roth IRAs and the fair-market-value conversion rule, and on Revenue Ruling 59-60, the IRS framework generally applied to valuing closely held interests.

How Discounts Work in Private Real Estate

Private interests in real estate funds and syndications have been valued at discounts to net asset value for decades, primarily for estate and gift tax purposes. The same valuation principles apply when the asset is moved from a traditional account to a Roth account.

Two discounts stack to produce the total NAV reduction. The Discount for Lack of Marketability (DLOM) reflects the absence of a ready buyer. An LP interest in a private real estate syndication cannot be sold on an exchange, has no established secondary market, and a holder who needed liquidity would have to accept a substantial price concession or wait for the deal's natural exit. The Discount for Lack of Control (DLOC), also called the minority-interest discount, reflects the absence of control. A fractional LP holder cannot direct property operations, force a sale, or compel a distribution, so a buyer of that position would pay less than a buyer of a controlling stake.

Revenue Ruling 59-60 sets the IRS framework for valuing closely held interests, instructing appraisers to consider business nature, economic outlook, book value, earning capacity, dividend capacity, goodwill, prior sales, and comparable public market prices. The framework was written for closely held corporate stock and has been applied broadly to fractional interests in private real estate vehicles.

Operationally, the sponsor engages a qualified third-party appraisal firm. The appraisal firm values the partnership interest using DLOM and DLOC under Revenue Ruling 59-60 factors. The sponsor reports the discounted value to the IRA custodian, who carries that value on the investor's account statements. Investors do not commission their own appraisal. Whether any offering carries a discount, and the magnitude, depends on the offering's structure, underlying assets, and the sponsor's appraisal at the time of investment.

Typical discount ranges vary by deal type.

Public sponsor disclosures have historically reflected discounts ranging from approximately 25% on multifamily ground-up development funds to 70% on oil and gas mineral rights interests. These figures reflect past sponsor disclosures and are not indicative of future discount availability on any specific deal. Actual discounts are established per offering by the sponsor's appraisal firm at the time of investment.

The Math at Three Scales: $50K, $250K, and $1M Conversions

A common misconception is that the discounted Roth conversion only works at large balances. The math is proportional within a given vehicle. The variable is the absolute dollar size of the savings, not the rate. The three scenarios below pair each balance scale with one of the three core vehicles introduced earlier, at the discount level typical of that vehicle.

Each scenario assumes the conversion tax is paid from outside the IRA. The vehicle, NAV discount level, and assumed federal marginal rate vary by scale.

• $50,000 conversion, 30% discount, 7-year hold. Vehicle: a ground-up multifamily development fund. The sponsor's appraisal firm reports $35,000 to the custodian because the building is still under construction, capital has been spent on land and permits, and rental income has not started. An outside buyer of the same position today would pay less than the original investment because the project's value has not yet materialized.
• $250,000 conversion, 60% discount, 5-year hold. Vehicle: an oil and gas drilling fund. The sponsor reports $100,000 to the custodian because by year-end most of the capital has been spent drilling wells that have not yet started producing meaningful cash flow. The appraised value reflects the projected future cash flows from the wells, not the dollars already spent drilling them.
• $1,000,000 conversion, 70% discount, 7-year hold. Vehicle: a mineral rights fund holding producing wells plus undeveloped acreage. The sponsor reports $300,000 to the custodian because the producing wells are valued on their projected cash flow and the undeveloped acreage is discounted heavily until more wells are drilled. The investor stages the conversion across two tax years to manage bracket exposure.

The above examples reflect capital returned plus any potential capital appreciation at exit. Actual investment returns will vary. Discount magnitudes vary by offering and are established per deal by the sponsor's appraisal firm at the time of investment. Past performance is not indicative of future results.

How to Potentially Cut the Conversion Tax to Zero with a Paired Drilling Fund

The discount alone may potentially reduce a conversion tax bill by 25% to 70%. Investors willing to take one additional step may potentially reduce the residual tax toward zero by pairing the discounted Roth conversion with a separate cash investment, made outside the IRA, in a qualifying oil and gas drilling fund. The dollars that would have gone to the IRS instead deploy into a working investment that may potentially pay cash distributions from the wells if and when they produce as expected.

The mechanic works because of how the tax code treats one specific category of oil and gas investment. When a drilling fund spends capital on drilling new wells, a large portion of that capital qualifies as an intangible drilling cost (IDC) deduction. For investors holding a general partner (GP) position in the fund during the drilling phase, the IDC deduction reduces ordinary income in the year the drilling occurs. Typical IDC deductibility ranges from 65% to 85% of capital contributed, depending on the fund's structure and the share of capital deployed to drilling versus tangible equipment. The GP position is the part that makes the offset reach ordinary income (the next paragraph explains why).

The key tax provision is IRC §469(c)(3), the working-interest exception. Most passive investments (real estate syndications, solar projects, private REITs) generally produce passive losses that can only offset passive income. Conversion income is generally treated as ordinary income, not passive income, so those passive losses generally cannot reach it under current law. The §469(c)(3) working-interest exception is the narrow carve-out: a general partner (GP) position in a drilling fund during the drilling phase may potentially produce nonpassive losses that can offset ordinary income, including the ordinary income recognized on the Roth conversion.

Worked Example: The $500K Conversion Taken to Zero

Consider a hypothetical scenario. Assume a $500,000 traditional IRA conversion. Without any discount, at a 32% combined federal-plus-state marginal rate, the conversion would generate approximately $160,000 of tax.

With a 60% NAV discount on a private real estate position, the appraised value reported to the custodian is $200,000. Conversion tax on $200,000 at 32% is approximately $64,000. The discount alone has already saved roughly $96,000.

To potentially take the residual conversion income toward zero, the investor makes a separate $235,000 cash investment outside the IRA into a drilling fund GP unit. At an 85% IDC ratio typical of an early-stage drilling fund, that investment may potentially produce approximately $200,000 of Year-1 IDC deduction. The $200,000 deduction may potentially offset the $200,000 of ordinary income from the conversion, bringing the net conversion income toward approximately zero, subject to the investor's full income picture, at-risk basis under IRC §465, and any AMT preference exposure.

Net conversion tax: approximately $0. The full $500,000 position still moves into the Roth IRA, where it may potentially continue to grow and eventually distribute tax-free, subject to Roth seasoning and the age 59.5 requirement. The $235,000 outside-IRA investment is now working capital in a producing drilling fund, which may potentially generate quarterly cash distributions from the wells over their productive life if and when wells produce as expected. Cash distribution timing and amounts are not assured. The dollars that would have gone to the IRS have instead become a working investment.

Illustrative only. Assumes a $500,000 conversion at a 32% combined marginal rate, a 60% combined valuation discount, and an 85% IDC on a paired $235,000 outside-IRA drilling investment. The outside-IRA investment is sized to produce IDC deductions that fully offset the conversion income; if the investment is smaller, the residual conversion income is partially offset rather than fully offset. Discount magnitudes, IDC percentages, and offset effectiveness vary by asset class, program structure, and individual tax circumstances. Consult a qualified tax professional.

Risks Specific to the Offset Layer

The IDC offset depends on the drilling fund being structured to satisfy the working-interest exception during the drilling phase, which typically requires the investor to hold a GP unit for the first 10 to 11 months of the program. The full GP-versus-LP structural mechanics, including the §469(c)(3) requirements, are covered in our Roth conversion loophole in private real estate article.

• AMT preference rules. Some IDC amounts can be treated as an alternative minimum tax preference item, depending on the taxpayer's overall income mix.
• Excess-business-loss limitations under IRC §461(l). May cap the deduction in any single tax year, deferring excess into a net operating loss carryforward.
• Offering-dependent. Not every drilling fund is structured to support the working-interest exception. Not every investor's income situation can absorb the deduction in the year it is generated.

Consult a qualified tax advisor before pairing a drilling fund with a Roth conversion. The mechanic only works when the drilling fund's IDC deduction, the investor's ordinary income exposure, and the conversion's timing line up in the same tax year.

Who This Strategy Is For (Two Profiles That Fit)

The discounted Roth conversion is a structural option, not a product. Two profiles tend to evaluate it most seriously.

Profile A: Approaching or in early retirement, planning around RMDs. Investors in their late 50s through early 70s with substantial traditional IRA or rollover IRA balances often weigh the future cost of required minimum distributions. Under SECURE 2.0, RMDs generally start at age 73 for those born between 1951 and 1959, and at 75 for those born in 1960 or later. Once RMDs begin, distributions are generally taxed as ordinary income, may push the retiree into higher brackets, may raise Medicare IRMAA premiums, and may increase the taxable portion of Social Security. Converting before RMD age may potentially reduce these effects, and the discounted conversion may potentially lower the upfront cost of doing that.

Profile B: Mid-career, growing balances, old 401(k) sitting untouched. Investors in their 30s and 40s frequently have a traditional rollover IRA from a former employer's 401(k), plus ongoing contributions. The compounding window is longer, and the discounted conversion moves balances to the Roth side at a reduced tax cost today, with the underlying investment locked in a 5-to-10-year private placement.

Five situations where the strategy tends to fit.

1. Approaching RMD age with a large traditional IRA to convert before mandatory distributions begin.
2. Old 401(k) sitting in a traditional rollover IRA with no plans to use the money for a decade or more.
3. Inherited IRA with a 10-year forced distribution window under the SECURE Act, where converting some balance early may reduce eventual tax compression.
4. Traditional IRA growing tax-deferred with no near-term need for the funds.
5. Estate planning context where reducing the taxable estate and leaving heirs a Roth balance is a goal.

Private placements are illiquid. Capital is committed for the hold period (typically 5 to 7 years), with no secondary market for most LP interests. The underlying investment also carries its own performance risk, including the risk of loss of principal, separate from the tax efficiency of the conversion structure.

The Mechanics Step by Step

The following describes the general operational process for educational context only. Individual circumstances vary materially. Investors should consult a qualified tax professional and a registered representative before executing any conversion. Nothing in this section constitutes tax, legal, or investment advice.

The discounted conversion is generally a sequence of operational steps. Each is straightforward in isolation. The coordination work runs between the custodian, the sponsor's appraisal firm, and the investor's tax advisor.

Step 1: Open a self-directed IRA at a qualified custodian. Standard brokerage IRAs typically restrict holdings to publicly traded securities. To hold a private real estate interest, the investor needs a self-directed IRA at a custodian that accepts alternative investments. Common custodians that allow private placements include Equity Trust, IRA Financial, Directed IRA, IRA Resources, and uDirect IRA. The custodian holds the asset and handles administration but does not provide investment advice on the private placements themselves.

Step 2: Find a Roth conversion eligible investment. The investor works with the Anchor1031 team to find a Roth conversion eligible investment on the Anchor1031 marketplace that matches their goals and risk tolerance. The sponsor of the chosen offering generally engages a third-party appraisal firm to establish a discounted valuation in the first 1 to 2 years of the investment. Discount availability and magnitude depend on the offering's structure and the sponsor's appraisal at the time of investment. Not every offering carries a discount.

Step 3: The sponsor's appraisal firm establishes the discounted value. The appraisal firm values the partnership interest using DLOM and DLOC under Revenue Ruling 59-60 factors, and the sponsor reports the discounted value to the IRA custodian. The investor does not commission a separate appraisal.

Step 4: Execute the conversion. The asset moves from the traditional self-directed IRA to a Roth self-directed IRA, and the taxable conversion amount equals the fair market value as reported by the custodian from the sponsor's appraisal. Roth conversions are generally irreversible under current tax law (recharacterization was eliminated by the Tax Cuts and Jobs Act for conversions after 2017). Investors typically discuss the decision with their CPA and registered representative before executing, given the irreversibility.

Pay the conversion tax with outside capital. Many investors pay the conversion tax from a taxable account (savings or brokerage) to preserve the full position inside the Roth. Pulling the tax payment from the IRA itself may trigger a taxable distribution on top of the conversion, reducing the amount inside the Roth and eroding the strategy's benefit.

Step 5: Hold the position inside the Roth IRA to deal exit. Most private placements have hold periods of 5 to 7 years or longer. There are no RMDs on the Roth side. The trustee or sponsor manages the property, and the investor's Roth IRA is a passive LP holder.

Step 6: Proceeds return to the Roth at exit. Capital plus any appreciation is deposited back into the Roth IRA. Because the asset is inside a Roth, the return of capital and any gains are generally not taxable upon qualified distribution, subject to Roth seasoning and the investor's age at distribution.

The IRA custodian reports the conversion to the IRS, and the investor reports it on IRS Form 8606 with the annual return. The sponsor updates the valuation annually inside the account. Because DLOM and DLOC persist throughout the hold period, the discounted carrying value may remain in place for several years (a 2-to-3-year planning window is commonly cited), though actual persistence depends on the sponsor's annual appraisal updates and deal performance. Not all offerings include NAV-discounted valuations, and Anchor1031 does not guarantee discount availability on any specific deal. The following describes the general process. Consult a tax advisor before taking action.

The Multiyear Conversion Ladder ("Creeping Conversion")

A multiyear sequence, often called a "creeping conversion" or staged Roth conversion, is the practical execution pattern for moving a substantial traditional IRA balance to the Roth side without spiking into a higher tax bracket in any single year.

Each year, the investor converts a portion of the traditional balance into a new private real estate interest at NAV discount, paying that year's conversion tax from outside capital. The following year, a new conversion runs against the remaining traditional balance using a different private interest with its own sponsor-disclosed appraisal. The sequence repeats across 3 to 5 tax years, each conversion a separate IRS tax event reported on Form 8606 for the corresponding year.

A simplified illustration. An investor with a $500,000 traditional IRA converts $100,000 each year for five years, using a different private interest each year, each at a sponsor-disclosed 40% discount. The taxable basis each year is approximately $60,000. By year five, the traditional balance is drained and five separate Roth positions sit inside the account, each at a different point in its hold period.

Tax bracket management is the ladder's secondary benefit. Spacing conversions across multiple tax years keeps each year's amount within a target marginal bracket. An investor who would have pushed into the 35% bracket on a single $500,000 conversion can keep each year inside the 24% bracket across five $100,000 conversions, depending on other income each year. The tax advisor should model projected income for each ladder year before the sequence is locked in.

Deal Types That Support Discounted Conversions

The deal type table earlier in this guide shows the typical discount range across three core vehicles: 25-40% for ground-up multifamily development, 40-60% for oil and gas drilling funds, and 40-70% for mineral rights funds. The range reflects each vehicle's stage in the investment lifecycle, the nature of its underlying assets, and the minority-position characteristics of an LP interest. Construction-stage multifamily sits at the lower end because the underlying asset is a familiar class with established valuation methods and the discount comes mostly from capital being deployed before rental income starts. Drilling funds run deeper because mid-completion wells have not yet produced meaningful cash flow at the time of appraisal. Mineral rights funds run highest because a significant share of the portfolio is undeveloped acreage that the appraiser discounts heavily until more wells are drilled.

Vehicle selection depends on the investor's risk tolerance, time horizon, and the sponsor's track record. Working with a self-directed IRA custodian that accepts private placements and a registered representative familiar with the strategy is generally how investors land on the right structure.

Tax Considerations, Limits, and Compliance Gates

The discounted conversion generally lives inside the same Roth conversion rules that govern any other conversion. The discount changes the basis of the tax calculation, not the rules themselves.

No income limit for Roth conversions. The Tax Increase Prevention and Reconciliation Act of 2005 is generally understood to have removed the MAGI limit on Roth conversions for tax years beginning in 2010. Any investor with a traditional IRA may potentially convert regardless of income under current law.

The conversion adds to ordinary income for the year. The discounted basis is generally added to the investor's other ordinary income, which may affect marginal bracket, may affect Medicare IRMAA premiums two years later, and may affect the taxable portion of Social Security benefits for retirees. Investors may want to discuss modeling projected total income for the year with a CPA before executing.

RMDs are generally not eligible for conversion. Once an investor reaches RMD age, the required minimum distribution is generally required to be taken first, before any additional amount can be converted. Under SECURE 2.0, RMDs generally begin at age 73 for investors born between 1951 and 1959, and at 75 for those born in 1960 or later.

Prohibited transactions under IRC Section 4975. Self-dealing between the IRA and disqualified persons (the account holder, spouse, ancestors, descendants, and certain entities) is generally prohibited and may void the IRA's tax-favored status. Investors may want to review the specific facts of any offering with a tax advisor before investing IRA funds.

The two 5-year clocks. Roth IRAs generally involve two separate 5-year rules under current law, and they do two different jobs. The first is the Roth seasoning clock. It generally starts with the investor's first Roth contribution or conversion, ever, and the Roth generally must be open at least 5 tax years before any earnings can come out tax-free. The second is the per-conversion clock. Each conversion generally starts its own separate 5-year clock, and this one matters only for investors under 59.5: pulling the converted amount back out before that clock runs may trigger the 10% early-withdrawal penalty, even though the converted principal itself is not taxed again. The two clocks generally run independently, so one can be finished while the other is still running.

SECURE 2.0 Roth 401(k) RMD elimination. Starting in 2024, Roth 401(k) accounts are generally no longer subject to RMDs during the participant's lifetime, which matters for investors using employer plan Roths as part of an estate plan. Roth conversions are generally irreversible under current law because the Tax Cuts and Jobs Act is generally understood to have eliminated recharacterization for conversions made after 2017.

The discounted conversion generally changes only the taxable basis on which the conversion tax is calculated. The downstream Roth treatment is generally identical to any other Roth balance.

What Can Go Wrong With a Discounted Roth Conversion

The discounted Roth conversion may produce meaningful tax savings, but the strategy stacks several execution risks on top of an already complex tax event. Most failures generally trace back to weak valuation support, custodial process errors, or a misread of how long capital is actually locked up. Investors may want to walk through each of the following with a qualified tax advisor before committing.

• IRS valuation challenge on an unsupported discount. The reported value is generally only as defensible as the third-party appraisal behind it. If the appraisal firm does not properly apply Revenue Ruling 59-60 factors (lack of marketability, lack of control, holding-period risk) or if the supporting workpapers are thin, the IRS may potentially challenge the discount on audit. A successful challenge generally results in a higher taxable conversion amount, back taxes, interest, and potentially accuracy-related penalties.
• Prohibited transactions inside the SDIRA. Self-dealing under IRC Section 4975 (transactions with disqualified persons, personal use of IRA-held property, or improper compensation flows) may potentially disqualify the entire IRA as of the first day of the year in which the transaction occurred. That outcome generally treats the full account balance as a taxable distribution and may trigger additional penalties for investors under 59.5.
• Illiquidity at the 5-year mark. Clearing the tax clocks is not the same as being able to take the money out. Even after the Roth seasoning clock has run, and for investors under 59.5 the per-conversion clock as well, the converted dollars are still sitting inside a private real estate fund or similar private placement. Those investments generally hold for 5 to 10 years and do not offer a redemption window on a fixed date, so the money generally becomes available only when the fund sells the underlying asset and distributes the proceeds. As a result, the converted balance may potentially stay locked in the offering past the point at which tax-free access would otherwise be available. Being eligible to withdraw tax-free and actually being able to withdraw are two different timelines.
• Custodian failure or fee surprises. Not every self-directed IRA custodian accepts every private placement, reports fair market value consistently each year, or processes in-kind distributions without delay. Annual asset-holding fees, transaction fees, and valuation-update fees may potentially add up over the life of the position and erode the math on a marginal conversion.
• Deal-level execution risk on the underlying property. The conversion math assumes the underlying private real estate fund or similar offering performs roughly as projected. Construction delays, lease-up shortfalls, refinancing failures, commodity-price moves, or sponsor missteps may potentially reduce or eliminate any potential appreciation that would have otherwise grown tax-free inside the Roth. A discounted conversion on a deal that loses money generally does not recover the tax paid up front.

For the complete list of Roth conversion mistakes across all strategies, see Roth Conversion Mistakes.

Worked Example: Profile A (Sarah, age 62)

Consider a hypothetical scenario involving Sarah, a 62-year-old retiree who recently left a corporate HR director role. She has a $250,000 rollover IRA from a former employer's 401(k) and is not yet collecting Social Security. Under SECURE 2.0, her RMD age is 73 (born 1964), giving her 11 years before forced distributions begin.

Sarah evaluates a discounted Roth conversion using a ground-up multifamily development fund that is still in its construction and lease-up phase. Capital is being deployed for land, permits, and construction; rental income has not yet started. A third-party appraisal firm applying Revenue Ruling 59-60 factors would typically support a 25-40% discount on a minority LP interest in a development-stage fund of this type. The sponsor's appraisal firm establishes a 40% discount on Sarah's $250,000 LP interest and reports $150,000 to the IRA custodian.

Taxable basis would be approximately $150,000. At a 24% federal marginal bracket, the estimated federal tax would be approximately $36,000 (assuming she stages the conversion to stay within the bracket). Had she converted at full nominal value, the federal tax would have been approximately $60,000. Illustrative savings would be approximately $24,000.

Sarah pays the approximately $36,000 from a savings account outside the IRA, and the full $250,000 position stays inside the Roth. The fund holds for 7 years from initial capital call through stabilization and exit, returning capital plus any potential appreciation from the sale of the developed multifamily property at year 7. She is 69, past 59.5, and her Roth is generally considered seasoned if she previously held any other Roth account.

Optional Second Layer: Drop the Conversion Tax to Zero

Rather than write the $36,000 check to the IRS, Sarah may potentially deploy that capital plus additional outside funds into a working investment that produces a Year 1 tax deduction large enough to offset her $150,000 of conversion income. She makes a $176,500 cash investment outside the IRA into a qualifying oil and gas drilling fund GP unit. At an 85% IDC ratio typical of an early-stage drilling fund, that investment may potentially produce approximately $150,000 of Year-1 IDC deduction. The $150,000 deduction may potentially offset the $150,000 of ordinary income from her conversion, bringing the net conversion tax toward approximately zero, subject to her full income picture, at-risk basis under IRC §465, and any AMT preference exposure.

Net effect of the paired strategy: Sarah keeps the full $250,000 multifamily position inside her Roth, where it may potentially continue to grow tax-free and exit with capital plus any potential appreciation at year 7. She holds a separate $176,500 position in a producing drilling fund outside the IRA, which may potentially generate quarterly cash distributions for the productive life of the wells if and when wells produce as expected. Cash distribution timing and amounts are not assured. And she pays approximately zero net federal tax on the conversion event, subject to her full income picture and at-risk basis. The dollars that would have gone to the IRS have instead become a working investment.

After approximately one year of holding the GP interest, once the IDC deduction has been recognized for tax purposes, the sponsor typically converts the position to a limited partner (LP) unit. This may potentially reduce liability exposure for the remainder of the fund's productive life while preserving the investor's share of any future cash distributions the fund may pay.

This is a simplified hypothetical and actual outcomes depend on individual circumstances. Discount levels are educational examples, not a representation of any live offering. The IDC offset depends on the drilling fund being structured as a GP unit during the drilling phase to satisfy IRC §469(c)(3) treatment, on the investor having sufficient ordinary income exposure to absorb the deduction in Year 1, and on the outside-IRA investment being sized to produce IDC deductions equal to the conversion income. Full structural detail is covered in the earlier section "How to Potentially Cut the Conversion Tax to Zero with a Paired Drilling Fund." Consult a tax professional for guidance on a specific situation.

Worked Example: Profile B (David, age 38)

Consider a hypothetical scenario involving David, a 38-year-old software engineer who left a tech company three years ago. He has a $200,000 traditional IRA rolled over from a former 401(k) and makes annual traditional IRA contributions. His goal: move the bulk of the balance to a Roth over several years, potentially reducing future RMDs and building a larger tax-free balance for retirement.

In year 1, David directs $50,000 of his traditional IRA into a mineral rights fund holding a portfolio of producing wells plus undeveloped acreage. A qualified appraiser values the producing wells on a present-value-of-cash-flow basis and discounts the undeveloped reserves heavily until more wells are drilled, so a position of this type would typically support a 40-70% discount on a minority LP interest. The sponsor's appraisal firm establishes a 60% discount on David's $50,000 LP interest and reports $20,000 to the IRA custodian.

Taxable basis would be approximately $20,000. At a 22% federal marginal bracket, the estimated federal tax would be approximately $4,400. At full nominal value, it would have been approximately $11,000. Illustrative year-1 savings would be approximately $6,600.

In year 2, David stages a second discounted conversion of another $50,000 from his traditional IRA, into a different mineral rights fund position with its own sponsor-engaged appraisal. Each conversion is a separate tax event with its own appraisal and discount. Spreading the conversion across two tax years keeps each year's marginal rate well inside the 22% bracket and avoids triggering IRMAA exposure later in life.

By the end of year 2, David has moved $100,000 of his $200,000 traditional balance into the Roth side. Cumulative federal tax paid across the two years: approximately $8,800 versus approximately $22,000 at full nominal value, for total illustrative savings of approximately $13,200. He continues laddering in subsequent years against the remaining $100,000 traditional balance. Over the productive life of each underlying mineral rights position, cash distributions plus residual capital accumulate back into the Roth as ordinary Roth funds. The ladder uses only NEW traditional-side balances at each step.

This is a simplified hypothetical and actual outcomes depend on individual circumstances. Tax year and bracket planning for a multiyear ladder should be done with a qualified tax advisor.

Explore the Private Real Estate Offerings

The discounted Roth conversion is not a do-it-yourself transaction. It requires coordination between the IRA custodian, the sponsor's appraisal firm, the investor's CPA, and a registered representative familiar with the strategy. Anchor1031 can help investors review potential investment opportunities where a discounted Roth conversion like this could be implemented.

If you want to explore the private real estate investments behind a discounted Roth conversion, talk with our team about the current offerings. No obligation. Just a clear look at the math.

Frequently Asked Questions

Sources

This article references the following IRS publications and Internal Revenue Code sections.

• 26 U.S.C. Section 408, Individual Retirement Accounts (Cornell Law)
• 26 U.S.C. Section 4975, Prohibited Transactions (Cornell Law)
• 26 U.S.C. Section 401(a)(9), Required Minimum Distribution rules
• IRS Form 8606, Nondeductible IRAs
• IRS Publication 590-A, Contributions to Individual Retirement Arrangements
• IRS Publication 590-B, Distributions from Individual Retirement Arrangements
• Revenue Ruling 59-60, Valuation of Closely Held Stock
• SECURE 2.0 Act of 2022, enacted as Division T of the Consolidated Appropriations Act of 2023, RMD age changes and Roth 401(k) RMD elimination