2015 Tax Reporting for Your Self-Directed IRA

Exterior image of the IRS building with the text "2015 Tax Reporting for Your Self-Directed IRA."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 accounts fair market value as of 12/31/15, 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 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.

 

April 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, buy 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

Most Frequently Asked Questions

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 12/31/15) 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 IRAs 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.

2014 Tax Reporting for Your Self-Directed IRA

Exterior image of the IRS building with the text "2014 Tax Reporting for Your Self-Directed IRA."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 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 accounts fair market value as of 12/31/14, 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 account preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1’s and not your personal SSN. If your IRA owns an LLC 100%, then it is disregarded (single member LLC) and the LLC does not need to file a tax return to the IRS. April 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, buy 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 (c-corp dividends exempt). Rental income (no debt leverage), interest income, capital gain income, and dividend income are exempt from UBIT tax. April 15th, 3 month extension available

 

Frequently Asked Questions

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 12/31/14) 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 IRAs cash (tax favorable treatment) and the portion that is debt (subject to UDFI/UBIT tax) and your IRA end 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. Our law firm is preparing and filing 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.

Tax Court Rules Against Self-Directed IRA Owner Who Failed to Properly Make a Real Estate Investment

Image of the US Tax Court logo with the text "IRA Ownership of an LLC: Self-Directed IRAs and IRA/LLCs."In a recent U.S. Tax Court case, the Court ruled against an IRA owner and deemed his IRA distributed and taxable as the IRA owner failed to properly execute his intended self-directed IRA real estate investment. Dabney v. Commissioner, T.C. Memo 2014-108.

The IRA owner had an IRA at Charles Schwab and intended to use the IRA to acquire real estate in Brian Head, UT. Upon conducting research Mr. Dabney learned that an IRA could own real estate. However, instead of rolling or transferring his IRA funds to a self directed IRA custodian who would allow his IRA to own real estate, Mr. Dabney took a distribution of the IRA and directed Schwab to wire the funds to closing for the purchase of the property. Additionally, he instructed title and eventually received a deed in the name of his Schwab IRA.

The problem was that rather than invest his IRA into real estate he instead distributed his IRA and use the distributed fund to buy real estate outside of his IRA. Charles Schwab issued Mr. Dabney a 1099-R for that distribution and Mr. Dabney contested the 1099-R and the taxes owed as a result arguing that the funds were used to buy a property owned by his Schwab IRA. Mr. Dabney argued that Charles Schwab made a mistake. However, the Court ruled against him because his funds were distributed out of his Charles Schwab IRA and because his IRA funds and the real estate were not held by a self-directed IRA custodian that allowed for IRAs to own real estate. The Court stated that an IRA can certainly hold real estate but that Charles Schwab’s policies did not allow for Mr. Dabney’s IRA to own real estate and since his custodian would not hold the real estate as an asset of his IRA that it was deemed distributed.

The lesson to be learned from the Dabney case is that in order to properly execute a self-directed IRA investment into an asset such as real estate, the IRA owner needs to roll over or transfer their IRA funds first to a self-directed IRA custodian who allows the IRA to own real estate and then that self-directed IRA will actually take title and ownership to the IRA asset directly. While these rules seem simple, I’d estimate that I speak to at least one or two IRA owners a year who took a distribution from an IRA and used those funds to buy real estate (or some other alternative asset) thinking that the real estate would still be owned by their IRA and that the funds would not be distributed and subject to tax. The confusion usually arises with the non-self directed custodian who misunderstands what the the account owner is trying to do (invest the IRA, not distribute it). Keep in mind, that in order to own real estate with a self-directed IRA, you must have a self-directed IRA custodian.

How to Document and Write Down a Failed IRA Investment

Photo of a man holding his head in front of three large stacks of file folders with the text " How to Document and Write Down a Failed IRA Investment."While every self directed IRA investor enters into investments with high hopes and expectations of large gains, sometimes an IRA has to declare a loss on its investments and sometimes those losses are total losses. However, how does an IRA document a loss on a private partnership investment or an uncollectible promissory note investment? Two Tax Court opinions released today show us what not to do. Berks v. Commissioner, T.C. Summary Opinion 2014-2, Gist v. Commissioner, T.C. Summary Opinion 2014-1.

Berks v. Commissioner and Gist v. Commissioner

In Berks and Gist, self directed IRA owners invested their IRAs into various real estate partnerships and had equity interests and promissory note interests. Approximately five years after the investments were made, the IRA owners sought to declare the values on all of the investments worthless as the partnerships were no longer in business and as the IRA owner was told by their friend who they invested with that the investments were worthless. The IRA custodian for Berks and Gist sought additional documentation before agreeing to write down the value of the investments. Writing down the value of an investment and closing an account is a red flag for the custodian and the IRS as both want to ensure that IRA owners are not unfairly writing down investments in an effort to avoid taking distributions from the IRA which are taxable. As a result, the IRA custodian sought documentation as to the valuation change and upon receiving no documentation; the IRA custodian distributed the account to the IRA owners with the original investment amounts made from the account.

The self directed IRA accounts were closed by the custodian and the IRA owners were responsible for the taxes due from the 1099-R as well as accuracy related penalties. Eventually the un-claimed 1099-R went into collections with the IRS and the IRS sought payment of the additional taxes owed. The taxpayers disputed the amounts owed and took the case to Tax Court. The case eventually proceeded to trial and the taxpayers both lost in separate cases because they went into the case with no documentation or evidence of collection attempts. Instead, there was only testimony from the IRA owner and from their advisor that assist them in the investments. In Berks, the Court stated, “…[the IRA owner] simply took Mr. Blazer [their friend they invested with] at his word, and they apparently never saw the need to request any documentation that would substantiate that the partnerships had failed or that the promissory notes in the IRA accounts had become worthless.” Accordingly, the Court ruled against the IRA owners and held that the investment values as reported by the custodian (the initial investment amounts) were the best representation of fair market value. As a result, the IRA owners were subject to taxes owed on the higher valuation amounts.

I handled a very similar case to this one in Tax Court myself. In my case, the case resulted in the IRS reducing the valuation of the distributed IRA down to the proper discounted fair market valuation the IRA owner was seeking. As a contrast to what the taxpayers did to document their losses in Berks and Gist (e.g., no documents or records), I have outlined the steps that should be taken to properly document a loss with your IRA custodian and/or with the IRS/Tax Court.

Documenting a Loss/Failed Investment

  1. Hire a Third Party to Prepare an Opinion as to Value. Your custodian, the IRS, and the Tax Court all want to see an independent person’s opinion as to the value of an investment.
  2. Provide Accounting Records Showing Losses and No Profits/Income. In my Tax Court case on the same issue (obviously different facts and investments), we were able to re-construct the accounting records and losses from the company that demonstrated the significant valuation change. These accounting records we assembled were accompanied by financial records and third party documents which supported our numbers. The IRS agreed with our decreased valuation before trial, and dismissed their case against our client.
  3. Document Fraud. If fraud was involved by persons receiving the income. Was a lawsuit filed? Were complaints made to regulatory bodies (e.g. SEC or state divisions of securities)? Provide those documents to your custodian.
  4. If the Investment Losses are from a Un-Collectible Promissory Note.
    1. Engage a lawyer or collection agency to make collection efforts. Keeps documents of their collection efforts.
    2. If the borrower filed bankruptcy, provide the bankruptcy documentation.
    3.  If the loan is totally un-collectible, Issue a 1099-C (Forgiveness of Debt Income to the Defaulted Borrower, you’ll need the borrower’s SSN/EIN for this).

The best way to document an investment loss is to provide a third party valuation to your custodian.  A custodian cannot accept an e-mail or letter from the IRA owner saying the investments didn’t pan out. If a third party opinion as to value cannot be produced, you’ll need to provide some of the records and documents I outlined above to demonstrate the loss. Remember, as Tom Cruise said in A Few Good Men, “It doesn’t matter what happened. It only matters what I can prove.” To prove an investment loss in your IRA, you’ll need documents and records showing what went wrong.