by Mat Sorensen | Aug 8, 2017 | Investing
The so-called “DOL Fiduciary Rule” went into effect in June and has caused negative repercussions on self-directed retirement account investors who self-directed their IRA, 401(k), or pension into alternative investments. Many self-directed investors have been shut out from investing into private offerings – real estate funds, private placements, start-ups, private REITs, etc. – as investment sponsors or private companies raising funds fear that, by accepting the self-directed retirement account’s investment, they will be labeled a “fiduciary” and will need to adhere to fiduciary rules really meant for investment advisers.
What is a Fiduciary?
The Department of Labor (“DOL”) recently expanded the definition of who a “fiduciary” is to include any person or entity who renders “investment advice” for a fee or other compensation. The fee doesn’t need to be from the compensation itself, but just has to flow from the investment. Here’s the problem: If you run a private fund, start-up, or a real estate partnership, and you take investment dollars from a retirement account, then the DOL definition may include you as a fiduciary since your investment documents will likely contain information that would be considered “investment advice.” And, since you will indirectly receiving compensation as a part of management of the fund or start-up, then you are indirectly receiving a fee for providing investment advice and may consequently be deemed a fiduciary.
Fiduciary Rule Repercussions
Most investment sponsors dread being labelled a fiduciary as they are placed with very high legal standards including as the duty of prudence, the duty of loyalty, and they have to avoid self-dealing prohibited transactions that may arise if they are receiving any compensation that isn’t found to be “reasonable”. In short, application of the fiduciary rule makes them re-align the company’s or management’s interests to be in the best interest of the invested retirement account. While this sounds like a good deal for the retirement account investor – and it is – it puts the interests of management at odds with the retirement account, and creates significant liability to management if they accept retirement plan dollars when they are a fiduciary.
The fiduciary rule was primarily intended to apply to an adviser advising a client so that the investment adviser recommended investments in the best interest of the client, not just the highest paying commission for the adviser. Although that makes sense, the new definition is so broad that it also could apply to the company raising funds from a self-directed IRA or 401(k), and force those companies to reject investment dollars from self-directed IRAs and 401(k)s.
Exceptions
There are two exceptions to the Fiduciary Rule that will allow a self-directed retirement account to invest into a private investment offering: Independent Fiduciaries and Best Interest Contract Exemption.
Independent Fiduciary
If the self-directed retirement account investor has an independent fiduciary, then that fiduciary is responsible for their investment advice and the offering company won’t be deemed a fiduciary. An independent fiduciary would include a registered investment adviser or a broker-dealer. Consequently, if a self-directed IRA investor had an investment adviser who reviewed the investment, then the offering company would likely not be deemed a fiduciary for this investment. I’ve seen numerous companies starting to require this for all retirement account investments. For those clients who already use an investment adviser, this is easier to comply with. But, most self-directed investors do not use an adviser, and as a result would need to spend money to engage one for the purposes of reviewing the investment just so they could qualify to invest.
Best Interest Contract Exemption (BICE)
The second exemption is the best interest contract exemption, otherwise known as “BICE.” BICE provides that a person is exempt from the fiduciary rule, but has lengthy requirements that really won’t work for an investment sponsor or someone raising private capital from an IRA. Based on the requirements, it will really only work for advisers or insurance companies offering financial products.
What to Do Moving Forward?
Many private investment offerings are not restricting self-directed accounts yet. They are either agreeing that they are fiduciaries and are taking that into account their company’s operations or they are taking the legal position that the fiduciary rule doesn’t apply to them, which may be correct as the law is new and still unclear. However, if you end up being restricted from investing your self-directed IRA or 401(k) into a private investment because the offering company is worried about the fiduciary rule, you may choose to rely on the Independent Fiduciary exemption and could engage an investment adviser – if you don’t already have one – to review this investment and serve as the fiduciary for the investment.
by Mat Sorensen | Apr 11, 2017 | News
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.
by Mat Sorensen | Feb 21, 2017 | News, UBIT & UDFI Tax
The 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.
- 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.
- 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.
- 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.
by Mat Sorensen | Jan 16, 2017 | News, Prohibited Transactions, UBIT & UDFI Tax
The 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:
- 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.
- 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.
- 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.
by Mat Sorensen | Dec 6, 2016 | News
The RISE Act proposed by Senator Ron Wyden of Oregon would significantly impact self-directed IRAs. I previously wrote about the bill here and provided a detailed analysis. In summary, the bill would require that all self-directed IRA investment purchases be valued by a third-party appraiser and reported on the IRA owner’s personal tax return. In addition, the Act would change the disqualified person rule for companies from 50% to 10%. The Act also greatly effects Roth IRAs and would eliminate Roth conversions and would cap Roth IRA accounts at $5M.
Here are few quick updates that are very important to the bill.
- Senator Orrin Hatch of Utah (R) has introduced the Retirement Enhancement and Savings Act of 2016. This bill is farther long in the process and addresses retirement account issues but is entirely un-related to Senator Wyden’s proposed RISE Act the impacts self-directed IRAs. I’ve had a few clients worried as they’ve ran across this bill as it is currently working its way through the Senate.
- Senator Wyden’s RISE Act is in proposed form and is out for comment until December 7, 2016. You can reply with comments to [email protected]. I will post my Comment in a subsequent blog article.
- While the bill is sponsored by Democrat Senator in a Republican controlled Senate, it is still vitally important that the Senate Finance Committee understand the roadblocks and burdens that the bills IRA provisions will cause to hundreds of thousands of Americans who are investing for retirement with their self-directed IRA.
- If your Senator is a member of the Senate Finance Committee, I would highly recommend sending focused and professional comments to your Senator regarding provisions that will hinder your ability to save and invest for retirement. The current members of the Senate Finance Committee can be found here.
Additionally, if you have comments or feedback relative to the proposed bill, please feel free to that to me at [email protected].
