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. They then 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. Last, 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 IRA’s 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 of 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. Call us at (888) 801-0010.
*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.
keys to house with home ownership documents
Real estate may be owned in your personal name, in a business name, or in a trust. You may have heard of revocable living trusts, corporations, LLCs, series LLCs, or limited partnerships. Here’s a quick guide to where you should own different types of properties.
1. Personal Residence
Your home should be owned in your revocable living trust. A living trust is an excellent choice to own your personal residence as the property can pass under the terms of your trust upon your death and your heirs won’t need to go to probate court to transfer ownership. If your residence is owned in your personal name it can only pass to your children/heirs after you’ve gone to probate court which requires far more legal fees and time than setting up a trust now. For homes with significant equity you may want to consider a domestic asset protection trust which can protect the equity in the home from personal creditors.
2. Rental Property
Your rental property should be owned in an LLC. Rental properties generate income and wealth but they can also create liabilities. If a rental property is owned in your personal name everything that happens on the home creates personal liability to you and a plaintiff can go after all of your personal assets, income, and wages. On the other hand, if a rental property is owned in an LLC the plaintiff will be required to sue the LLC and can’t go after the LLC owner personally. In certain states where you have lots of properties you may want to consider a series LLC which provides liability protection in the LLC between multiple properties such that if something happens to one property in the series LLC it doesn’t effect the other properties in the series LLC. An LLC owned by one person or a married couple isn’t too difficult to manage and generally doesn’t require a separate LLC tax return. Instead, you report the property and its profit/loss on your personal return in the same way you ‘d report the profit/loss if you owned it in your personal name. In most instances, limited partnerships should not be used to hold rental properties as your tax losses and write offs are restricted when you own them in a limited partnerships.
3. Land or Second Home
Your land or second home should be owned in your revocable living trust. Again, this helps keep your assets coordinated with your estate plans and outside of probate court. For land or second homes with significant equity you may want to consider a limited partnership or domestic asset protection trust which can protect the property from the owner’s personal liabilities. Generally, an LLC is not used unless the property itself creates liability. For example, if you rent your second home or cabin you may want an LLC for liability protection but most second homes or parcels of land do not create liability and therefore do not need an LLC.
4. Where Should Properties Never Be Held
Except for short short term real estate holds (under one year) properties should not be owned in a s-corporation and should never be held in a c-corporation. Additionally, we rarely recommend clients use land trusts to own property for asset protection purposes as land trusts provide little actual asset protection beyond making the owner of the property difficult to determine at the county records.
There are lots of options and many nuances to how you should own your real estate. For a more detailed and specific analysis for your properties please contact the law firm for an estate and asset protection plan that fits your needs. We can also assist with deed transfers to get your properties into the right place.
A recent article on Forbes by Bryan Ellis outlines the importance in making sure you understand self-directed IRA rules before you invest. Check out the excellent article and a quote from yours truly here. Also, Bryan has a significant amount of additional resources on his self-directed IRA website which you can access here.
When analyzing asset protection for self directed IRAs we must consider two types of potential threats. First, we must analyze how a creditor can collect against an IRA when the creditor has a judgment or claim against the IRA owner personally. Secondly, and most importantly for self directed IRA owners, we must analyze how a creditor can collect against an IRA or its owner when the IRAs investment incurs a claim or judgment.
There has been much written on the protections to retirement plans that prevents a creditor of the IRA owner from collecting against the IRA to satisfy their judgment. Various federal and state laws provide this protection which prohibits a creditor of an IRA owner from collecting or seizing the assets of an IRA or other retirement plan. For example, if an individual personally defaults on a loan in his or her personal name and then gets a judgment against them the creditor may collect against the individual’s personal bank accounts, non retirement plan investment accounts, wages, and other non-exempt assets but is prohibited from collecting against the IRA or other retirement plans of the individual. Even in the case of bankruptcy a retirement plan is considered an exempt asset from the reaches of the creditors being wiped out. U.S. Bankruptcy Code, 11 U.S.C. §522. Because of these asset protection benefits retirement plans are excellent places to hold assets outside the reach or creditors.
The second asset protection issue and the focus of this article is to consider how an is IRA protected from claims arising from the IRA’s investments and activities? This issue is one that is particularly important to self directed IRA accounts since some self directed IRA investments are made into assets that can create liability to the IRA and the protections preventing a creditor of the IRA owner against the IRA assets does not apply to liabilities arising from the IRAs investments. In other words, if the IRA has a liability the IRA is subject to the claims of creditors. For example, if a self directed IRA owns a rental property and the tenant in that property slips and falls the tenant can sue the self directed IRA who owned and leased the property to the tenant. Consequently, the IRAs assets are subject to the collection of the creditor including the property the IRA owned and leased to the tenant as well as the other assets of the IRA. But what about the IRA owner and their personal assets, are their personal assets also at risk?
Let’s analyze this issue further and look at whether a creditor/plaintiff against the IRA can also sue the IRA owner personally if the IRA’s assets are not sufficient to satisfy the judgment against the IRA. IRC § 408 states that an IRA is a trust created when an individual establishes an IRA by signing IRS form 5305 (this form is completed, with some variations, with every IRA) with a bank or qualified custodian. Courts have analyzed what an IRA is under law and have stated that they are a trust or special deposit of the individual for the benefit of the IRA owner. First Nat’l Bank v. Estate of Thomas Philip, 436 N.E. 2d 15 (1992). In other words, the IRA is not a separate entity or trust which would be exempt from creditor protection of its underlying owner. Since the IRA is a trust that is revocable and terminated at the discretion of the IRA owner, each investment in fact is truly controlled by the IRA owner as her or she could terminate the IRA at any time and take ownership in their personal name. As a result, the IRA is akin to a revocable living trust used for estate planning which trust is commonly understood by lawyers and courts to provide no asset protection and prevention of creditors from pursuing the trust creator and owner from liabilities and judgments that arise in the trust. Following this same rationale, a self directed IRA would likely be subjected to a similar downfall in the event of a large liability which is not satisfied by the assets of the IRA. As a consequence, the personal assets of the IRA owner may be at risk.
As a result of the asset protection liabilities for self directed IRAs, we recommend that self directed IRA owners consider an IRA/LLC for the asset protection reasons that many individuals use LLC’s in their personal investment and business activities. Simply put, an LLC prevents the creditor of the LLC from being able pursue the owner of the LLC (in this case the IRA). An IRA/LLC is an LLC owned typically 100% by the IRA and the LLC would operate and take ownership of the investments and the liabilities similar to an LLC used by an individual. For example, instead of the IRA taking ownership of a rental property directly and leasing it to a tenant the IRA/LLC would instead take title to the property and would lease the property to the tenant. When the IRA/LLC owns and leases the property any claims or liabilities that arise are contained in the LLC and as a result of the LLC laws a creditor is prevented from going after the LLC owner (in this case the IRA, or the IRA owner).
There are certain types of self directed IRA investments that benefit greatly from the asset protection offered by an IRA/LLC. Rental real estate owned by an IRA achieves significant asset protection benefits from an IRA/LLC since rental real estate can create liabilities to their owner. Other self directed IRA investments such as promissory note loans, precious metals, or land investments do not have the same asset protection issues and potential to create liability for the IRA and as a result an IRA/LLC isn’t as beneficial from an asset protection perspective for these types of investments.