by Mat Sorensen | Oct 25, 2016 | News
The Retirement Improvements and Savings Enhancements Act (“RISE Act“) has drastic changes and provisions that effect self-directed IRA investors. From mandatory third-party valuations on all retirement account investment transactions to changing the 50% disqualified company rule to 10%, the bill has some significant changes that will negatively affect your ability to self-direct your account. There are some favorable provisions for IRA owners, however, the negatives greatly outweigh the positives.
Most Important Provisions
The bill sponsor is Sen. Ron Wyden (D-OR) who is the Ranking Member of the Senate Finance Committee and the Joint Committee on Taxation. Here’s a quick run-down of the most troublesome provisions that apply to self-directed IRA investors:
- Valuation Purchase/Sale Requirement. Mandatory Valuation Requirement for Private IRA (non-public stock market) Transactions: The new proposal seeks to require gifting valuation rules and standards for IRA transactions. This rule will force IRA owners to get a valuation before making any private investment. This valuation would include real estate, private company (e.g. LLC, LP, corporation), and note investments. The gifting valuation rules were created to value gifts where no value is set between a buyer and seller. mandating those same rules on actual transactions between an IRA and another unrelated party is unrealistic and unnecessary to establish actual fair market value.
- 50% Rule is Reduced to a New 10% Rule: Changes the 50% rule that states a company is a disqualified person to an IRA when it is owned 50% or more by disqualified persons (e.g. IRA owner and certain family). The new rule makes a company disqualified when owned 10% or more by disqualified persons.
- Roth IRAs Capped at $5M: Roth IRAs will be capped at $5M. Any amount over $5M must be distributed from the Roth IRA.
- Eliminate Roth Conversions: Traditional IRA funds cannot be converted to Roth IRA funds. Roth IRAs will be allowed only if the account owner makes initial Roth IRA contributions and only when they meet the Roth IRA contribution limits, which restricts high-income earners.
- Require RMD for Roth IRAs: Roth IRAs are currently not subject to required minimum distribution (“RMD”) rules because the amounts distributed do not result in tax. This rule will change and RMD will apply to Roth IRAs when the account holder reaches age 70 ½.
These proposals will have drastic impacts on self-directed IRA investors. The valuation requirement is perhaps the most dramatic as it will require valuations before an IRA can buy an asset and before it can sell an asset. Not only will this cause administrative issues and increased costs, but it will undoubtedly replace the ability of an IRA buyer or an IRA seller from transacting their IRA at the price and value they determine to represent the actual current fair market value of their investments.
I have written a detailed analysis of the bill which I plan to share with the Senate Finance Committee and the Joint Committee on Taxation. I welcome your input as a self-directed IRA investor and plan to advocate for common-sense rules that help self-directed investors take control of their retirement. My draft bill analysis can be accessed at the link below. Please send your comments to [email protected].
draft-rise-act-2016-analysis-by-mat-sorensen
by Mat Sorensen | Aug 4, 2016 | UBIT & UDFI Tax
Unrelated Business Income Tax (“UBIT”) is often misunderstood by self-directed IRA investors and their professional advisors. In essence, UBIT is a tax that is due to an IRA when it receives “business income” as opposed to “investment income”. When we think of IRAs and retirement accounts, we think of them as receiving income without having to pay tax when the income is made. For example, when your IRA sells stock for a profit and that profit goes back to your IRA you don’t pay any tax on the gain. Similarly, when you sell real estate owned by your IRA for a profit and that profit goes back to your IRA, you don’t pay any tax on the gain. The reason for this is because the gain from the sale of an investment asset is deemed investment income and as a result it is exempt for UBIT tax.
Tip 1: “When Does UBIT Apply?”
UBIT applies when your IRA receives “unrelated business income”. However, if your IRA receives investment income, then that income is exempt from UBIT tax. Investment income that is exempt from UBIT includes the following.
Investment Income Exempt from UBIT:
- Real Estate Rental Income, IRC 512(b)(3) – The rent of real estate is investment income and is exempt from UBIT
- Interest Income, IRC 512(b)(1) – Interest and points made from the lending of money is investment income and is exempt from UBIT.
- Capital Gain Income, IRC 512(b)(5) – The sale, exchange, or disposition of assets is investment income and is exempt from UBIT.
- Dividend Income, IRC 512(b)(1) – Dividend income from a c-corp where the company paid corporate tax is investment income and exempt from UBIT.
- Royalty Income, IRC 512(b)(2) – Royalty income derived from intangible property rights such as intellectual property and from oil/gas and mineral leasing activities is investment income and is exempt from UBIT.
There are two common areas where self-directed IRA investors run into UBIT issues and are outside of the exemptions outlined above. The first occurs when an IRA invests and buys LLC ownership in an operating business (e.g. sells goods or services) that is structured as a pass-thru entity for taxes (e.g. partnership) and that that does not pay corporate taxes. The income from the LLC flows to its owners and would be ordinary income. If the company has net taxable income it will flow down to the IRA as ordinary income on the k-1 and this will cause tax to the IRA as this will be business income and it does not fit into one of the investment income exemptions.
The second problematic area is when IRAs engage in real estate investment that do not result in investment income. For example, real estate development or a number of significant short-term real estate flips by an IRA will cause the assets of the IRA to be considered as inventory as opposed to investment assets and this will cause UBIT tax to the IRA.
Tip 2: UBIT Applies When You Have Debt Leveraging an IRA Investment
UBIT also applies to an IRA when it leverages its purchasing power with debt. If an IRA uses debt to buy an investment, then the income attributable to the debt is subject to UBIT. This income is referred to as unrelated debt financed income (UDFI) and it causes UBIT. The most common situation occurs when an IRA buys real estate with a non-recourse loan. For example, lets say an IRA buys a rental property for $100,000 and that $40,000 came from the IRA and $60,000 came form a non-recourse loan. The property is thus 60% leveraged and as a result, 60% of the income is not a result of the IRAs investment but the result of the debt invested. Because of this debt, that is not retirement plan money, the IRS requires tax to be paid on 60% of the income. So, if there is $10K of rental income on the property then $6K would be UDFI and would be subject to UBIT taxes.
For a more detailed outline on UDFI, please refer to my free one-hour webinar here.
Tip 3: UBIT Tax is Reported and Paid by the IRA via a Form 990-T Tax Return
Unrelated business income tax (UBIT) for an IRA is reported and paid via IRS Form 990-T. IRS Form 990-T is due for IRAs on April 15th of each year. IRA owner’s can file and obtain an automatic 6-month extension with the IRS by filing an extension request before the regular deadline.
If UBTI Tax is due, it is paid from the IRA and the IRA owner would send the prepared Form 990-T to their IRA custodian for their signature and for direction of payment to the IRS for any tax due as part of the 990-T Return.
For a more detailed outline of UBIT, please refer to Chapter 15 of The Self Directed IRA Handbook.
by Mat Sorensen | May 10, 2016 | News
Many investors and financial professionals are familiar with the primary benefits of a Roth IRA: that the plans investments grow tax-free and come out tax-free. But if tax-free investing isn’t enough to get you excited, rest assured, there are more benefits to the Roth IRA. I’ll note just three more in this article.
Remember, Roth IRAs are for nearly everyone with earned income. They’re not restricted to high income earners. Check out my prior article here if you’re unfamiliar with the back-door Roth IRA. Okay, now lets over the other perks of Roth IRAs.
No Required Minimum Distributions
First, Roth IRAs are not subject to RMD. Traditional retirement plan owners are subject to rules known as Required Minimum Distribution rules which require the account owner to start taking distributions and paying tax on the distributions (since traditional plan) when the account owner reaches the age of 70 ½. Not being subject to RMD rules allows the Roth IRA to keep accumulating tax free income (free of capital gain or other taxes on its investment returns) and allows the account to continue to accumulate tax free income during the account owner’s life time. Learn more about the facts and fiction about IRA RMDs here.
Spousal Rollover: The Best Asset to Leave to Your Spouse
Second, a surviving spouse who is the beneficiary of a Roth IRA can continue contributing to that Roth IRA or can combine that Roth IRA into their own Roth IRA. Allowing the spouse beneficiary to take over the account allows additional tax free growth on investments in the Roth IRA account. Non spouse beneficiaries (e.g. children of Roth IRA owner) cannot make additional contributions to the inherited Roth IRA and cannot combine it with their own Roth IRA account. The non-spouse beneficiary becomes subject to required minimum distribution rules but can delay out required distributions up to 5 years from the year of the Roth IRA account owner’s death and is able to continue to keep the tax free return treatment of the retirement account for 5 years after the death of the owner. The second option for non-spouse beneficiaries is to take withdrawals of the account over the life time expectancy of the beneficiary (the younger the beneficiary the longer they can delay taking money out of the Roth IRA). The lifetime expectancy option is usually the best option for a non-spouse beneficiary to keep as much money in the Roth IRA for tax free returns and growth.
Tax and Penalty Free Withdrawals Before Age 59 ½ On What You Put In
Third, Roth IRA owners are not subject to the 10% early withdrawal penalty for distributions they take before age 59 ½ on amounts that are comprised of contributions or conversions. Growth and earning are subject to the early withdrawal penalty and taxes too, but you can always take out the amounts you contributed to your Roth IRA or the amounts that you converted without paying taxes or penalties (note that conversions have a 5 year wait period before you can take out funds penalty and tax free). This makes the Roth IRA the most powerful savings account out there because you can take out what you put in without penalty or tax for whatever reason you may have as hardship is not required. Traditional IRAs have no such benefits.
Roth IRAs are a great tool for many investors. Keep in mind that there are qualification rules to being eligible for a Roth IRA that leave out many high income individuals. However, you can convert your traditional retirement plan dollars to a Roth IRA (sometimes known as a backdoor Roth IRA) as the conversion rules do not have an income qualification level requirement on converted amounts to Roth IRAs. This conversion option has in essence made Roth IRAs available to everyone regardless of income.
by Mat Sorensen | Apr 6, 2016 | Prohibited Transactions
by Mat Sorensen | Feb 1, 2016 | News
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.
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