When an IRA owner withdraws cash from a Traditional IRA, they are typically taxed on the amount distributed. If a self-directed IRA owner takes an in-kind distribution of an alternative asset such as real estate, however, how will the IRA custodian report the distribution? How will the IRS assess taxation? To track sources of potentially taxable income, federal tax law requires IRA custodians to obtain and report the fair market value of IRA assets and certain investments.
The value of IRA assets and investments is needed to perform a variety of custodial functions:
• Annual reporting of the fair market value of the IRA and certain hard-to-value investments
• Determining value and taxation for distributions, in-kind transfers, and conversions
• Calculating and reporting amounts for RMDs and beneficiary distributions
To properly complete these functions, IRA custodians must obtain valuations of each investment owned by the IRA. Accurately valuing certain types of alternative investments with no readily ascertainable value, such as private equity, real estate, or business ventures, can be challenging.
IRA custodians do not typically perform the valuations on alternative investments themselves, and generally will not accept a valuation from the IRA owner. Rather, most custodians require the IRA owner to engage a qualified independent third party to provide a valuation. In the case of real estate investment, for example, valuations are typically completed by a certified real estate appraiser or a licensed real estate broker. Documentation supporting the valuation may also be required, especially for assets that are in bankruptcy or foreclosure. IRS Revenue Ruling 59-60 outlines an approach, method, and factors to consider when determining the value of assets that do not have a readily ascertainable market value. The responsibility and time frames for delivering the annual valuations to the custodian are often included in the IRA plan agreement or other documentation used as part of the IRA establishment process.
STRATA requires that IRA owners obtain the Fair Market Valuation (or good faith estimate) each year and provide it to STRATA to ensure proper reporting for the IRA. STRATA requires that a valuation be provided annually or prior to one of the following events:
• You take distribution of an asset in-kind
• You convert or recharacterize an asset
• You transfer an asset in an account to beneficiaries
• There has been a major change in asset value
STRATA will use the valuations obtained by self-directed IRA owners to complete the following required reporting.
Fair Market Value: must be provided to IRA owners and beneficiaries by January 31 each year. It contains the value of the IRA as of December 31 of the prior year.
IRS Form 5498: must be provided to IRA owners, beneficiaries, and the IRS by May 31 each year. It reports the fair market value of the IRA as well as all contributions made to the IRA in the prior year. Form 5498 also separately reports the year-end fair market value of certain types of hard-to-value assets held in an IRA, including,
• Stock or other ownership interest in a corporation that is not readily tradable on an established securities market
• Short- or long-term debt obligation that is not traded on an established securities market
• Ownership interest in a limited liability company or similar entity (unless the interest is traded on an established securities market)
• Real estate
• Ownership interest in a partnership, trust, or similar entity (unless the interest is traded on an established securities market)
• Option contract or similar product that is not offered for trade on an established option exchange
• Other asset that does not have a readily available fair market value
IRS Form 1099-R: must be provided to IRA owners and beneficiaries by January 31 each year a distribution is taken from the IRA. It reports the value of the distribution and any tax withholding and indicates whether the asset distributed is one of the hard-to-value assets reported on Form 5498. The IRS will use the distribution amount to assess taxation, in combination with information the IRA owner provides with their tax return (e.g., Form 8606, Nondeductible Assets). Due dates to the IRS fall in February and March depending on the IRA custodian’s filing format.
For more information, please see our recent article, “Reporting Fair Market Values For Alternative Assets” or view our Fair Market Valuation Update Request instructions and form.
If you have questions about valuation or alternative investment options, please contact us at 866-928-9394 or Service@StrataTrust.com.