Self-Directed IRA Valuations: Why Does My Self-Directed IRA Custodian Ask for a Valuation Update Every Year?

If you have a self-directed IRA with non-publicly traded assets like real estate, private stock, or an LLC interest, you’ve definitely been asked for an annual fair market valuation for the assets in your account. Why does your IRA custodian ask for this every year? Because they have to.

An IRA must report its fair market value to the IRS annually. Fair market value is reported to the IRS by your IRA custodian via IRS Form 5498. For standard IRAs holding stocks or mutual funds, those account values are automatically determined as they simply take the stock or fund price as of the close of the market on December 31st each year, and they use these amounts to set the year-end account fair market value. For self-directed accounts, such fair market values are not readily available and it becomes the IRA account owner’s responsibility to obtain their self-directed investment values so that their custodian can properly report the account’s fair market value. The value of an account is important for a few reasons. First, the IRS requires it to be updated annually. Second, it is used to set required minimum distributions (“RMDs”) for those account holders over the age of 70 ½ with traditional IRAs. Lastly, the account value is used when converting an entire account, or a particular investment or portion of the account, from a traditional IRA to a Roth IRA.

WHAT IS FAIR MARKET VALUE

Fair market value of an investment has been broadly defined by the Court as:

“The price at which property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.” U.S. v. Cartwright, 411 US 546 (1973).

Now here’s the hard part: Even though the IRS requires IRAs to update their fair market value on an annual basis, the Government Accountability Office noted in their recent report that:

“Current IRS guidance includes NO [emphasis added] guidance or advice to custodians or IRA owners regarding how to determine the FMV [fair market value]”. United States Government Accountability Office, GAO-17-02, Retirement Security Improved Guidance Could Help Account Owners Understand the Risks of Investing in Unconventional Assets. (Dec. 2016).

The absence of guidance, however, has not relieved IRA owners or their custodians from obtaining and reporting this information. While there is no specific fair market valuation guidance for IRAs, there are commonly accepted methods of reporting value used by professionals and companies within the self-directed IRA industry. Most of these methods have been adopted from law and regulations governing employer retirement plans or estates.

METHODS TO BE USED BY ASSET TYPE

The table below outlines preferred valuation methods that are commonly used in the industry for the most common self-directed IRA assets. As you will note, when the valuation is needed for a taxable event, such as a distribution or Roth conversion, greater detail and supporting information will be required as the valuation will result in tax being due.*

Asset Non-Taxable (Annual FMV) Taxable (RMD, distribution or conversion)
Real Estate Comparative Market Analysis (CMA) from a real estate professional is preferred. Some IRA custodians accept property tax assessor values or Zillow reports in non-taxable situations. Real estate appraisal is preferred. Some IRA custodians accept a broker’s price opinion.
Promissory Note Value of a note can be reported by calculating the principal due plus any accrued and unpaid interest. This is the valuation method used for calculating the value of a note for estate tax purposes. Same as non-taxable, principal amount due plus accrued and un-paid interest. For notes in default, a third-party opinion as to value is typically required in order for the note to be written-down below face value.
Precious Metals For bullion, use the spot value of the metal in question times the ounces owned. Spot value is widely reported on a daily basis on financial sites.

For acceptable coins, use market data for the coin in question via the Grey Sheets available at www.bullionvalues.com.

Same as non-taxable.
LLC, LP, or Private Company Interest Obtain a third party-opinion of value of the LLC interest. The opinion should rely on IRS Revenue Ruling 59-60. For asset holding companies, the valuation should focus on the value of the assets. For operating companies, the valuation should focus on earnings. Similar requirement, but the detail of the opinion should be more significant. For example, for an asset holding company where the IRAs interest is determined by the assets of the LLC. A CMA would be acceptable for calculating that assets value in the company in an annual valuation. However, an appraisal of the real estate to calculate in that asset would be required in a taxable situation.

Since the valuation reporting policies of custodians vary, IRA owners should make sure that they understand their IRA custodian’s policies for valuations for the assets in question.

Our firm routinely assists clients with obtaining third-party opinions of value and can assist IRA owners who need to produce a report or third party opinion as to an LLC or other investment interest held by an IRA.

* Please note that there are clearly differences of opinions on these matters, and since there is no specific legal guidance for IRA valuations, please keep in mind that the table above is based on my own industry experience and opinions. Seek a licensed professional in all instances for your specific situation.

IRA Contribution Deadlines: Two Out of Three IRA Types Can’t be Extended

You have until April 18th, 2017 to make 2016 IRA contributions for Roth and Traditional IRAs. If you’re self-employed and are using a SEP, your deadline is determined by your company’s tax filing deadline (e.g. s-corp, partnership, or sole prop). So, if you were an s-corp or partnership in 2016, then your filing deadline was March 15th, 2017. II you are a sole prop, then the deadline is April 18th, 2017. If you extended your company return, that extension will also apply to your SEP IRA contributions. The table below breaks down the deadlines and extension options for Traditional, Roth and SEP IRAs.

Type of IRA Contribution Type Deadline Details
Traditional IRA Traditional, Deductible April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 219(f)(3); You can file your return claiming a contribution before the contribution is actually made.  Rev. Rul. 84-18.
Roth IRA Roth, Not Deductible April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7).
SEP IRA  Employee, Deductible N/A: Employee contributions cannot be made to a SEP IRA plan.
Employer Contribution, Deductible March 15/April 15th: Due Date for Company Tax Return Filing (including extensions). IRC § 404(h)(1)(B).

As outlined above, you have until the 2016 individual tax return deadline of April 18th, 2017 to make 2016 Traditional and Roth IRA contributions. The deadline for Traditional and Roth IRAs, however, does not include extensions. So, even if you extend your 2016 tax return, your 2016 Traditional and Roth IRA contributions are still due on April 18th, 2017.

SEP IRA contribution deadlines are based on the company tax return deadline, which could be March 15th if the company is taxed as a corporation (“c” or “s”) or partnership, and April 15th if it is a sole proprietorship. Keep in mind that this deadline includes extensions, so if you extend your company tax return filing, you will extend the time period to make 2016 SEP IRA contributions.

New 990-T Filing Rule for Self-Directed IRAs

IRS Logo Blog Update ImageThe IRS recently released updated the extension rules for 990-T tax returns that are required for certain self-directed IRAs. Form 990-T is a tax return that must be filed by an IRA when it receives what is known as unrelated business taxable income (“UBTI”). For a description on UBTI and 990-T returns in general, see my prior article here.

The new rules allow an IRA to receive a automatic 6 month extension of time to file by filing IRS Form 8868. Previously, IRAs required to file a 990-T, were only allowed an automatic 3 month extension. The new extension procedures were released in January 2017 and apply to 2016 990-T returns. To claim the extension, the IRA must take the following steps.

  1. Obtain a Tax ID/EIN for the IRA. Generally, IRAs do not have their own Tax ID/EIN and they should not obtain one, except when a 990-T return needs to be filed. The Tax ID/EIN can be obtained at IRS.gov.
  2. Complete and File the Extension Request Using IRS Form 8868. The automatic 6-month extension for the filing of a 990-T is obtained by filing IRS Form 8868.
  3. File the Extension by April 15th. The regular filing deadline for form 990-T is the 15th day of the fourth month following the tax year (e.g. April 15th each year). Make sure the extension is filed by April 15th and keep a copy as you’ll need to send a copy with the extended return. Keep in mind, the extension to file is not an extension to pay so if you end up owing UBIT and if your IRA hasn’t made any tax deposits you may have a small amount of penalty and interest due when you later file and pay.

If your self-directed IRA investments are running into UBIT, make sure you’re reporting and paying any applicable UBIT via form 990-T to the IRS. Failure to do so can result in penalties, interest, and potentially loss of the IRA’s tax preferred status. If you’re not ready to file by April 15th, make sure you file the automatic extension request to give yourself 6 more months to file.

Roth IRA Conversion Re-Characterization: One “Do-Over” the IRS Allows

image4144Are you having second-thoughts about your Roth IRA Conversion? Did the value of your IRA decrease after you converted it? Are you unable to pay the tax on the conversion? If so, you’re in luck as you can re-characterize your Roth IRA back to a traditional IRA and you can avoid the taxes due too. Given the ups and downs of investments, this may be an excellent strategy for those whose account has decreased since their conversion in 2016.

If you have converted a Traditional IRA to a Roth IRA in 2016, you can reverse the conversion by doing what is called a Roth IRA conversion re-characterization. Under a re-characterization, the Roth IRA funds and assets are rolled back into a Traditional IRA, and the amounts converted are considered contributed to the traditional IRA and you effectively cancel out the amounts converted. As a result of the re-characterization, the taxes that would have been owed for the Roth IRA conversion are no longer due, and the assets and funds re-characterized go back to a Traditional IRA.

A Roth IRA conversion re-characterization is an excellent strategy in two situations. First, if you do not have the funds to pay the taxes on the conversion. Reversing the re-characterization will remove the tax liability. Problem solved. Second, if the investments in your Roth IRA, following the conversion, did not fare so well and if the account decreased in value you are generally better off re-characterizing the conversion and going back to a traditional IRA and then conducting a new Roth IRA conversions at the lower valuation. If you have completed a Roth IRA conversion re-characterization, you do have to wait until the next year to convert the same amounts back to Roth as the IRS restricts you from immediately re-converting after a re-characterization.

Here are a few keys facts to keep in mind for Roth IRA conversion re-characterizations:

1. You must coordinate the re-conversion with your IRA custodian as they will need to roll the Roth IRA funds back to a Traditional IRA. Your tax return also needs to properly report the re-conversion so that you don’t end up paying taxes on the 1099-R you will have received for the Roth IRA conversion.

2. You can re-characterize up to October 15th of the year following the year you converted. So if you conducted a Roth IRA conversion in 2016, you have until October 15, 2017 to re-characterize the conversion. You have until October 15th even if you did not file an extension and even if you have already filed your tax return for the prior year. If you filed a tax return already and claimed the Roth IRA conversion amounts as income, the tax return will need to be amended.

3. Roth 401(k) or other employer in-plan Roth conversions cannot be re-characterized so once those are reported to the IRS you cannot reverse them as the rules applicable to Roth IRA conversion re-characterizations do not apply to 401(k) or other in-plan Roth conversions.

Because of the re-characterization rules, the decision to convert funds to a Roth IRA isn’t as “taxing” as you’d think as you can later have a change of heart if the odds don’t end up in your favor (e.g. lower investment value, or no personal funds to pay taxes on the conversion).

More details and information can be obtained from an informative FAQ page from the IRS here.

By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.

GAO Report on Self-Directed IRAs Concludes IRS Lacking in Three Key Areas

image4280The Government Accountability Office (“GAO”) concluded over a year of research and investigation on self-directed IRA’s and 401(k)’s with a report to Congress called Retirement Security: Improved Guidance Could Help Account Owners Understand the Risks of Investing in Unconventional Assets.

Self-directed IRA’s and 401(k)’s are accounts that may be invested into “unconventional” assets. The most common “self-directed” assets are real estate, LLC’s, start-ups, venture capital, private funds, and precious metals. The self-directed IRA industry has tripled over the past ten years and the demand and interest from retirement account holders continues to grow.

The GAO was tasked to research self-directed IRA’s by Senator Ron Wyden (D-OR) who serves as the ranking member of the Senate Finance Committee.

The GAO identified 27 custodians who handle self-directed IRA’s holding “unconventional” assets such as real estate, LLC’s, private company stock, and precious metals. Seventeen of these companies participated and responded to surveys and requests for information. These 17 companies reported holding 500,000 retirement accounts and $50 Billion in assets in unconventional investments.

I was interviewed by the GAO for this report and they also used my book, The Self-Directed IRA Handbook, while conducting research on the laws and taxes affecting self-directed IRA and 401(k) investors.

The GAO’s report concluded that IRS guidance is lacking in three specific areas:

  1. Prohibited Transactions: The GAO concluded that self-directed account holders who invest in unconventional assets are at greater risk of engaging in prohibited transactions and that the IRS should engage in additional outreach and education with regards to unconventional assets to ensure compliance. The prohibited transactions rules are found in IRC § 4975 and essentially restrict the account owner, and certain family members, from transacting personally with their own IRA. For example, it would be a prohibited transaction for an IRA owner to sell private stock they personally own to their own IRA. It is also a prohibited transaction to have use or benefit of your IRA’s assets. For example, if your IRA owned real estate, it would be a prohibited transaction to have personal use or occupancy of the property.
  1. UBTI (Unrelated Business Taxable Income): The GAO’s research and investigation concluded that many self-directed IRA and 401(k) investors are unaware of the unrelated business taxable income (“UBTI”) that can apply to some “unconventional” investments owned by an IRA. UBTI tax applies to IRA’s when they receive “business” income as opposed to “investment” income. IRA’s are designed to receive investment income such as rental income, interest income, dividend income, or capital gain income. However, if an IRA receives “business” income or “ordinary” income, that causes UBTI and the IRA ends up being responsible for tax on its income. In this instance, the IRA files a 990-T tax return and is responsible for tax on the income earned. Most self-directed IRA investments do not cause UBTI, but many self-directed investors unwittingly run into this tax. The GAO found in its report that there isn’t any guidance regarding UBTI in the IRS publications on IRA’s, Publications 590-A and 590-B. The GAO warned that without caution or specific guidance in these publications or through other efforts by the IRS, that self-directed account owners may unwittingly invest their account into assets that cause UBTI tax.
  1. Fair Market Valuations: The GAO’s report found that there is zero advice to custodians of IRA’s or to IRA owners regarding how to determine the fair market value (“FMV”) for unconventional assets held in a retirement account. Each year, the custodian of a self-directed IRA must report the FMV of the account to the IRS via form 5498. For publicly traded assets such as stocks or mutual funds, valuation is relatively simple as the valuations is the price of the stock or fund as of close of the market price on December 31 each year. For assets such as real estate or private company stock, such value is not as readily available and account holders and companies use varying methods for reporting FMV annually to the IRS. The GAO recommended that the IRS develop guidance or regulations on how unconventional assets should be valued and reported to the IRS. In their response to the report, the IRS stated that they will recommend that Treasury address fair market valuations in their upcoming retirement plan regulations for 2016-2017

The GAO report was an excellent analysis and summary of the common issues facing self-directed IRA and 401(k) owners investing in unconventional assets. As an attorney representing self-directed account holders for over ten years, I wholeheartedly agree with the three issues the GAO cited in their report and believe that further guidance from the IRS would increase awareness for not only account holders but also for their professional tax, legal, and financial advisers.

2016 Self Directed IRA Tax Reporting Requirements

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Self-Directed IRA investors should be aware of the following IRA tax reporting responsibilities.  Some of these items are completed by your custodian and some of them are the IRA owner’s sole responsibility. Here’s a quick summary of what should be reported to the IRS each year for your self-directed IRA.

IRA CUSTODIAN FILES – Your IRA Custodian will file the following forms to the IRS annually.

IRS FORM PURPOSE WHAT DOES IT REPORT
Form 5498 Filed to the IRS by your custodian. No taxes are due or paid as a result of Form 5498.  

IRA contributions, Roth conversions, the account’s fair market value as of 12/31/16, and required minimum distributions taken.

 

Form 1099-R Filed to the IRS by your custodian to report any distributions or Roth conversions. The amounts distributed or converted are generally subject to tax and are claimed on your personal tax return. IRA distributions for the year, Roth IRA conversions, and also rollovers that are not direct IRA trustee-to-IRA trustee.


IRA OWNER’S RESPONSIBILITY – Depending on your self-directed IRA investments, you may be required to file the following tax return(s) with the IRS for your IRA’s investments/income.

IRS FORM DOES MY IRA NEED TO FILE THIS? DUE DATE
1065 Partnership Tax Return If your IRA is an owner in an LLC, LP, or other partnership, then the Partnership should file a 1065 Tax Return for the company to the IRS and should issue a K-1 to your IRA for its share of income or loss. Make sure the accountant preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1’s and not your personal SSN (or your IRAs Tax ID if it has one for UBIT 990-T tax return purposes). If your IRA owns an LLC 100%, then it is disregarded for tax purposes (single-member LLC) and the LLC does not need to file a tax return to the IRS. March 15th, 6-month extension available
990-T IRA Tax Return (UBIT) If your IRA incurs Unrelated Business Income Tax (UBIT), then it is required to file a tax return. The IRA files a tax return and any taxes due are paid from the IRA. Most self-directed IRAs don’t need to file a 990-T for their IRA, but you may be required to file for your IRA if your IRA obtained a non-recourse loan to buy a property (UDFI tax), or if your IRA participates in non-passive real estate investments such as: Construction, development, or on-going short-term flips. You may also have UBIT if your IRA has received income from an active trade or business such as a being a partner in an LLC that sells goods and services (C-Corp dividends exempt). Rental real estate income (no debt leverage), interest income, capital gain income, and dividend income are exempt from UBIT tax. April 15th, 3-month extension available

I’ve answered the most frequently asked questions below as they relate to your IRA’s tax reporting responsibilities.

Q: My IRA is a member in an LLC with other investors. What should I tell the accountant preparing the tax return about reporting profit/loss for my IRA?

A: Let your accountant know that the IRA should receive the K-1 (e.g. ABC Trust Company FBO John Doe IRA) and that they should use the Tax-ID of your custodian and not your personal SSN. Contact your custodian to obtain their Tax ID. Most custodians are familiar with this process, so it should be readily available.

Q: Why do I need to provide an annual valuation to my custodian for the LLC (or other company) my IRA owns?

A: Your IRA custodian must report your IRA’s fair market value as of the end of the year (as of 12/31/16) to the IRS on Form 5498 and in order to do this they must have an accurate record of the value of your IRA’s investments. If your IRA owns an LLC, they need to know the value of that LLC. For example, let’s say you have an IRA that owns an LLC 100% and that this LLC owns a rental property and that it also has a bank account with some cash. If the value of the rental property at the end of the year was $150,000, and if the cash in the LLC bank account is $15,000, then the value of the LLC at the end of the year is $165,000.

Q: I have a property owned by my IRA and I obtained a non-recourse loan to purchase the property. Does my IRA need to file a 990-T tax return?

A: Probably. A 990-T tax return is required if your IRA has income subject to UBIT tax. There is a tax called UDFI tax (Unrelated Debt Financed Income) that is triggered when your IRA uses debt to acquire an asset. Essentially, what the IRS does in this situation is they make you apportion the percent of your investment that is the IRA’s cash (tax favorable treatment) and the portion that is debt (subject to UDFI/UBIT tax) and your IRA ends up paying taxes on the profits that are generated from the debt as this is non-retirement plan money. If you have rental income for the year, then you can use expenses to offset this income. However, if you have $1,000 or more of gross income subject to UBIT, then you should file a 990-T tax return. In addition, if you have losses for the year, you may want to file 990-T to claim those losses as they can carry-forward to be used to offset future gains (e.g. sale of the property).

Q: How do I file a 990-T tax return for my IRA?

A: This is filed by your IRA and is not part of your personal tax return. If tax is due, you will need to send the completed tax form to your IRA Custodian along with an instruction to pay the tax due and your custodian will pay the taxes owed from the IRA to the IRS. Your IRA must obtain its own Tax ID to file Form 990-T. Your IRA custodian does not file this form or report UBIT tax to the IRS for your IRA. This is the IRA owner’s responsibility. Our law firm prepares and files 990-T tax returns for our self-directed IRA and 401(k) clients. Contact us at the law firm if you need assistance.

Sadly, not many professionals are familiar with the rules and tax procedures for self-directed IRAs so it is important to seek out those attorneys, accountants, and CPAs who can help you understand your self-directed IRA tax reporting obligations. Our law firm routinely advises clients and their accountants on the rules and procedures that I have summarized in this article and we can also prepare and file your 990-T tax return.

By: Mat Sorensen, Attorney and best-selling author of The Self Directed IRA Handbook.