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.
Retirement account/plan contributions are one of the most powerful tax strategies you can implement but you’ve got to make them by the deadline so that they can reduce this years tax liability. With the end of the year fast approaching, now is the time to make certain you are maximizing this important tax strategy for your 2014 tax planning. Please find below a table outlining the deadlines for 2014 retirement plan contributions according to your type of retirement account. If you are self-employed, you’ll notice the deadline also may depend on the type of company you own (e.g. s-corp or LLC) but also whether you are making contributions as an employee of your company and/or as the employer. First, let’s summarize the IRA contribution deadlines.
IRA Contribution Deadlines
|Type of IRA||Contribution Type||Deadline Details|
|Traditional IRA||Traditional, Deductible||April 15, 2015, 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 15, 2015, Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7).|
|SEP IRA ||Employee||N/A; employee contributions cannot be made to a SEP IRA plan.|
|Employer Contribution||March 15/April 15th, Due Date for Company Tax Return Filing (including extensions). IRC § 404(h)(1)(B).|
|Simple IRA ||Employee Elective Deferral||January 30, 2015. IRC § 408(p)(5)(A)(i).|
|Employer Contribution||March 15/April 15, Due Date for Company Tax Return Filing (including extensions). IRC § 408(p)(5)(A)(ii).|
In summary, for traditional and roth IRA contributions you have until the individual tax return deadline of April 15, 2015 to make 2014 contributions. SEP and SIMPLE IRA contribution deadlines are based on the company tax return deadline which could be March 15th if the company is a corporation and April 15th if it is a sole proprietorship or partnership. Keep in mind that this deadline does NOT include extensions so even if you extend your personal tax return filing to September 15, 2015, you still have a April 15, 2015, contribution deadline for Roth and Traditional IRAs.
401(k) Contribution Deadlines
|Solo 401(k)||Business Structure||Type of Cont.||Deadline Details|
|401(k), including self-directed Solo 401(k) (plan must be adopted by 12/31/14)||Sole Proprietorship||Employee Elective DeferralContribution||April 15, 2015, contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105.|
|Employer Profit Sharing Contribution||April 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105.|
|S-CorporationOr C-Corporation||Employee Elective Deferral contribution||March 15, 2015 (corporation filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105.|
|Employer Profit Sharing Contribution||March 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105|
|Partnership (e.g. partnership LLC)||Employee Elective Deferral Contribution||April 15, 2015 (partnership return filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and Election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105.|
|Employer Profit Sharing Contribution||April 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105.|
There are a few important things to keep in mind regarding 401(k) contributions.
401(k) Contribution Deadlines Can Be Extended
First, the contribution deadline for employer and employee contributions is the company tax return deadline INCUDLING extensions. So, if you have a solo 401(k) you can extend your company tax return and your contribution deadline is also automatically extended. For example, if you have a solo 401(k) plan adopted by your s-corporation, then your s-corporation tax return deadline is March 15, 2015, but that can be extended 6 months until September 15, 2015, upon filing an extension to extend the company tax return with the IRS. If you do this, you’d have until September 15, 2015, to make the 2014 employee and employer contributions. That being said, the employee contributions are taken from your salary/wages and if you make traditional 401(k) employee contributions those amounts are reported on your personal W-2 and reduce your taxable wages. The W-2 is effectively where your tax deduction for traditional employee contribution arises is it reduces your taxable wages on your W-2. As a result, you’ll need to make or at least know the amount you intend to make for employee contributions by January 31, 2015 as that is the W-2 filing deadline for 2014.
New 401(k)s Must Be Adopted by December 31st
Second, if you are establishing a new Roth or Traditional IRA, you can create that new account at the time of the IRA contribution deadline. However, if you are establishing a new solo 401(k) plan, you must have the plan established by December 31, 2014. Because there are a number of documents and procedures required to create a new 401(k) plan, this is not something that can be left to the last minute and you should start immediately if you intend to open a 401(k) this year.
Make 2014 Contributions in 2014
And lastly, while the deadlines for most 2014 retirement plan contributions for IRAs and 401(k)s runs into 2015, to keep things simple and stress-free we recommend making 2014 contributions by December 31, 2014, when possible.
As you can see, the contribution deadlines vary depending on the type of account/plan but also on the type of contribution. With respect to contributions to a self-directed solo 401(k), the contribution deadline also varies depending on the type of company you own that has adopted the plan. Therefore, it is important that you understand these deadlines and don’t miss out on an opportunity to maximize your tax deductions. For guidance on the contribution limits in 2014, please click here.
As previously stated, it is not too late to setup a retirement account/plan if you have not done so already. The deadline to set up a 401(k) and to make contributions for 2014 is typically the last day of the year, although I wouldn’t wait until the last day or even the last week of the year to do so. If you are interested in setting up a self-directed solo 401(k), please contact us immediately as we are helping clients establish these and so that we can get it set up before the end of the year.
Contingency clauses are some of the most important components of a real estate purchase contract, and can provide significant protections to buyers of real estate. A contingency clause typically states that a buyer’s offer to buy property is contingent upon certain things. For example, the contingency clause may state, “The buyer’s obligation to purchase the real property is contingent upon the property appraising for a price at or above the contract purchase price.” Under this contingency, the buyer is relieved from the obligation to buy the property if the buyer obtains an appraisal that falls below the purchase price. Because contingency clauses provide the buyer a way to back-out of a contract they can be excellent tools for real estate investors who make numerous offers on properties.
Contingency Clause Examples
Here are some contingency clauses to consider in your real estate purchase contract.
1. Financing Contingency. A financing contingency clause states something like, “Buyer’s obligation to purchase the property is contingent upon Buyer obtaining financing to purchase the property on terms acceptable to Buyer in Buyer’s sole opinion.” Some financing contingency clauses are not well drafted and will provide clauses that say simply, “Buyer’s obligation to purchase the property is contingent upon the Buyer obtaining financing.” A clause such as this can cause problems as the Buyer may obtain financing under a high rate and thus may decide not purchase the property. However, because the contingency only specified whether financing is obtained or not (and not whether the terms are acceptable to buyer), the clause can be unhelpful to a buyer deciding not to purchase the property. Some financing clauses are more specific and, for example, will say that the financing to be obtained must be at a rate of at most 7% on a 30 year term and that if the buyer does not obtain financing at a rate of 7% or lower then the buyer may exercise the contingency and back out of the contract.
2. Inspection Contingency. An inspection contingency clause states something like, “Buyer’s obligation to purchase is contingent upon Buyer’s inspection and approval of the condition of the property.” Another variation states that the Buyer may hire a home inspector to inspect the property and that the Seller must fix any issues found by the inspector and if the Seller does not fix the items specified by the inspector then the Buyer may cancel the contract. Inspection clauses are very important as they ensure that the Buyer is obtaining a valuable asset and not a money pit full of defects and repair issues.
Other important contingency clauses are clear and marketable title clauses, approval of seller disclosure documents, and rental history due diligence information (e.g., rent rolls, lease copies, financials, etc.).
Contingency Clause Issues
When using contingency clauses buyers should pay attention to a few key terms. I’ve personally seen many disputes arise as a result of one of the following issues.
1. What Happens to the Earnest Money. One important consideration that is often vague in real estate purchase contracts is what happens to the buyer’s earnest money when the buyer exercises a contingency. Does the buyer receive a full return of the earnest money? Does the seller keep the earnest money? If the contract is silent and if you as the buyer exercise a contingency, don’t count on the seller agreeing to a release of the earnest money as they are often upset that you are not going to purchase the property. Make sure the contract clearly states something like the following, “If Buyer exercises any contingency, Buyer shall receive a full return of any earnest money deposit or payment to Seller.”
2. Contingency Deadlines. Another important contingency clause issue is the date of the contingency clause deadline. Most contingency clauses have expiration dates that occur well before closing. Those dates should typically be somewhere from 2 weeks to 2 months from the date of the contract, depending on the purchase and seller disclosure items and the type of property being purchased. For example, single family homes will typically have a shorter window as financing and inspection can occur more quickly than would occur under a contract to purchase an apartment building. Whatever the deadline is, make sure that the deadline is set far enough out so that you can complete your contingency tasks. You need to make sure you have enough time to obtain adequate financing commitments, to properly inspect the property, and that you have enough time to review the seller’s disclosure documents. Setting a two week deadline is sometimes done but two weeks is usually not enough time to complete financing commitments, inspection, and due diligence activities that are necessary to determine whether you are going to commit to purchasing the property. If contingency deadlines are approaching and you need more time, then ask the seller for an extension before the deadline arrives. If the Seller refuses an extension, then exercise the contingency you need more time to satisfy.
3. Exercise You Contingency in Writing. If you do exercise a contingency and decide to back-out of the purchase of the property, make sure you do it in writing. Don’t rely on telephone calls or even e-mails (unless the contract permits e-mails as notice). Additionally, make sure that the reason for the contingency and that the date of the contingency are put in writing and are sent to the seller in a method where the date can be tracked in accordance to the notice provisions of the contract. For example, if the contract requires a contingency to be noticed by fax or hand delivery, don’t rely on an e-mail to the seller or the seller’s agent as such communication will not invoke the contingency.
Once the deadline to exercise a contingency has passed, the buyer is obligated to purchase the real property and may be sued for specific performance (meaning they can be forced to buy) or at the least the buyer will lose their entire earnest money deposit. Contingency clauses are the best defense mechanism to a bad deal and should always be used by real estate buyers. Keep in mind that until you close on the property, the only investment you have is a contract and if you have a bad contract, then you have a bad deal.
Many business owners and investors doing business in multiple states often ask the question of whether their company, that is set up in one state needs to be registered into the other state(s) where they are doing business. This registration from your state of incorporation/organization into another state where you do business is called a foreign registration. For example, let’s say I’m a real estate investor in Arizona and end up buying a rental property in Florida. Do I need to register my Arizona LLC that I use to hold my real estate investments into Florida to take ownership of this property? The answer is generally yes, but after reviewing a few states laws on the subject I decided to outline the details of when you need to register your LLC or Corporation into another state where you are not incorporated/organized. (Please note that the issue of whether state taxes are owed outside of your home state when doing business in multiple states is a different analysis).
Analyzing the Need for Foreign Registration
In analyzing whether you need to register your out of state company into a state where you do business or own property it is helpful to understand two things: First, what does the state I’m looking to do business in require of out of state companies; and Second, what is the penalty for failure to comply.
State Requirements for Businesses
First, a survey of a few state statutes on foreign registration of out of state companies shows that the typical requirement for when an out of state company must register foreign into another state is when the out of state company is deemed to be “transacting business” into the other state. So, the next question is what constitutes “transacting business”. The state laws vary on this but here are some examples of what constitutes “transacting business” for purposes of foreign registration filings.
- Employees or storefront located in the foreign registration state.
- Ownership of real property that is leased in the foreign registration state. Note that some states (e.g. Florida) state that ownership of property by an out of state LLC does not by itself require a foreign registration (e.g. a second home or maybe land) but if that property was rented then foreign registration is required.
Here is an example of what does not typically constitute “transacting business” for foreign registration requirements.
- Maintaining a bank account in the state in question.
- Holding a meeting of the owners or management in the state in question.
So, in summary, the general rule is that transacting business for foreign registration requirements occurs when you make a physical presence in the state that results in commerce. Ask, do I have employees or real property in the state in question that generates income for my company? If so, you probably need to register. If not, you probably don’t need to register foreign. Note that there are some nuances between states and I’ve tried to generalize what constitutes transacting business so check with your attorney or particular state laws when in question.
Failure to File Foreign Registration
Second, what is the penalty and consequence for failing to file a foreign registration when one was required? This issue had a few common characteristics amongst the states surveyed. Many company owners fear that they could lose the liability protection of the LLC or corporation for failing to file a foreign registration when they should have but most states have a provision in their laws that states something like the following, “A member [owner] of a foreign limited liability company is not liable for the debts and obligations of the foreign limited liability company solely by reason of its having transacted business in this state without registration.” A similar provision to this language was found in Arizona, California and Florida, but this provision is not found in all states that I surveyed. This language is good for business owners since it keeps the principal asset protection benefits of the company in tact in the event that you fail to register foreign. On the other hand, many states have some other negative consequences to companies that fail to register foreign. Here is a summary of some of those consequences.
- The out of state company won’t be recognized in courts to sue or bring legal action in the state where the business should be registered as a foreign company.
- Penalty of $20 per day that the company was “transacting business” in the state when it should have been registered foreign into the state but wasn’t. This penalty maxes out at $10,000 in California. Florida’s penalty is a minimum of $500 and a maximum of $1,000 per year of violation. Some states such as Arizona and Texas do not charge a penalty fee for failure to file.
- The State where you should have registered as a foreign company becomes the registered agent for your company and receives legal notices on behalf of your company. This is really problematic because it means you don’t get notice to legal actions or proceedings affecting your company and it allows Plaintiff’s to sue your company and to send notice to the state without being required to send notice to your company. Now, presumably, the state will try to get notice to your company but what steps the states actually takes and how much time that takes is something I couldn’t find. With twenty to thirty day deadlines to respond in most legal actions I wouldn’t put much trust in a state government agency to get me legal notice in a timely manner nor am I even certain that they would even try.
- In addition to the statutory issues written into law there are some practical issues you will face if your out of state company is not registered into a state where you transact business. For example, some county recorders won’t allow title to transfer into your out of state company unless the LLC or corporation is registered foreign into the state where the property is located. It is also common to run into insurance and banking issues for your company until you register foreign into the state where the income generating property, employee, or storefront is located.
In summary, you should register your company as a foreign company in every state where you are transacting business. Transacting business occurs when you have a storefront in the foreign state, employees in the foreign state, or property that produces income in the foreign state. Failure to file varies amongst the states but can result in penalties from $1,000 to $10,000 a year and failure to receive legal notices and/or be recognized in court proceedings. Bottom line, if you are transacting business outside of your state of incorporation/organization you should register as a foreign entity in the other state(s) to ensure proper legal protections in court and to avoid costly penalties for non-compliance.
Many real estate investors and landlords often ask whether they should use an umbrella insurance policy or a LLC to protect them from liabilities that may arise on their rental property. An LLC protects the owner of the LLC from liabilities that arise on any property in the LLC and prevents a plaintiff from being able to go after the LLC owner personally. As a result, we often say that an LLC protects a business owner’s personal assets from the risks and liabilities of the LLC business. An umbrella policy is coverage above and beyond the typical property insurance and covers additional risks and adds additional coverage to a typical property insurance policy.
Issues and Factors
There are many issues and factors to consider in making this decision and there is no one-sized fits all recommendation. In many instances we recommend that you have both an LLC and an umbrella policy and in other instances we may recommend just an LLC or just an umbrella policy. The first factor to consider is the cost. The cost of an LLC in our office is $800 and on average you can expect about $200 in fees a year to keep that LLC active with the State (about $900 annually in California, each state is different). As a result, the major cost of an LLC is in the first year but you can plan on having about $200 in fees each year (each state is different) to keep your LLC active. If you have a partnership LLC then you also have the cost of a LLC partnership tax return but the LLC also provides a significant amount of partnership advantages and protections.
An umbrella policy on the other hand is typically paid for monthly. Let’s say you are able to get $1M in umbrella protection at a cost of $50 a month. That would run you about $600 a year. Insurance policies have benefits which include attorneys whom the insurance company will appoint and pay to defend you (and protect themselves from having to pay) but also contain certain exclusions to coverage that may leave you with no coverage for the liability you incur. Another important factor to consider is the type of property you own. If you own a multi-unit property or commercial property we would recommend having both an LLC and an umbrella policy because you have more liability exposure when you have more tenants. On the other hand, if you have a single family rental in an otherwise good neighborhood where you feel less likely to be sued then we may only recommend an LLC or an umbrella policy on its own. Bottom line, consider both an LLC and an umbrella policy in your analysis and get quotes and advice upon which to make an informed decision so that you are protecting your assets in the most efficient and effective way as possible.