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Rules and Regulations

The Do's and Don'ts of Self-Directed IRAs

A unique facet of self-directed IRAs (SDIRAs) is the fact that they are tax-advantaged retirement savings accounts regulated by exclusive, rather than inclusive, IRS rules.  Detailed below is a general overview of IRS rules and regulations, useful tips for maintaining a tax-advantaged status, and important tax reporting requirements that are crucial for investors to be aware of both before and during the investment process.  Click on each tab to explore.

Understanding IRA Rules

Self-directed IRA investors should be aware of the IRS prohibited transaction rules and investments considered off-limits.

Prohibited Transactions

Making a prohibited transaction can cause you to lose the tax-deferred status of your account and incur subsequent taxes and penalties. This would also erase any gains you have earned because your account will be disqualified by the IRS. Prohibited transactions are determined by intent. Basically, any transaction that is intended for immediate personal financial gain rather than for your future retirement is considered prohibited.

×Personally borrowing money from the IRA

×Selling, leasing, or exchanging property to the account

×Accepting unreasonable compensation for managing property or assets held by the IRA

×Using the account as security for a loan

×Granting account fiduciaries permission to obtain, use, or borrow against account assets for their own gain

×Transferring plan assets, lending money, or providing goods and services to disqualified persons*

*Disqualified Persons are defined as the account holder and his/her spouse, lineal descendants, account fiduciaries, trustees, investment managers and advisors, and any corporate entity in which the account holder has at least a 50% ownership. See IRC 4975 for a comprehensive explanation of prohibited transactions.

Non-Allowed Investments

The great thing about SDIRAs is the investment flexibility they allow. In fact, the IRS has a fairly short list of investments that aren’t allowed—and beyond that, it is up to the IRA custodian to determine the assets it will or will not custody.

The guidelines below are simply to ensure that you understand which investments you can’t make with your IRA funds without risking significant penalties and tax implications. See IRC Section 408 or IRS Publication 590-A and IRS Publication 590-B for additional information.

×Collectibles such as artwork, coins, stamps, rugs, antiques, beverages, and other personal property

×Gemstones and metals (except for certain U.S. coins and bullion which are allowed)

×Insurance contracts

×S-Corp stock (typically not permitted because allowing an IRA investor to purchase S-Corp stock may disqualify the favorable tax status of this structure)

Understanding IRA Rules

Because an IRA is a tax-advantaged account, there are IRS rules on how money flows in and out of the account.

Contribution Rules and Limits

If you are eligible to make an annual IRA contribution, you may contribute up to the maximum annual amount allotted for the current tax year, and for those 50+ you may include the catch-up contribution amount.  Contributions can be made as often as you like during the year (monthly, quarterly, etc.) as long as you do not exceed your eligible limit.

The deadline for making an IRA contribution is generally April 15 (the federal tax filing deadline), and the envelope must be postmarked to STRATA Trust Company (not to an IRA-owned investment or to your dealer) no later than the annual tax filing deadline (excluding extensions) if contributing for the prior tax year. If contributing for the current tax year, your contribution can be made as early as January 1.

You may refer to STRATA’s IRA Annual Limits chart for the most current IRS contribution amounts for Traditional, Roth, SEP, and SIMPLE contribution limits.

Required Minimum Distributions

Required Minimum Distributions (RMDs) are mandatory minimum withdrawal amounts that must be taken annually by the Traditional IRA owner. As a result of the SECURE Act (passed Dec. 20, 2019), RMDs must begin within the year the IRA owner turns 72 years of age. RMDs must be taken no later than December 31 each year. However, the initial RMD may be postponed until April 1 of the year following the calendar year in which the IRA owner reaches age 72.

IRA owners are responsible for taking the correct amount of RMDs on time every year, or they will face stiff penalties for failure to do so. Roth IRA owners do not have to take RMDs.

At STRATA, as a courtesy to our account owners, your RMD amount will be calculated and provided to you based on your preferred method of communication delivery by January 31st each year.

Understanding IRA Rules

In circumstances where self-directed IRA assets are invested in certain types of income-generating investments, the IRA itself is required to pay tax each year on the investment income—referred to as UBTI or UDFI. It is the responsibility of the IRA owner to determine whether there is UBTI or UDFI to be reported and, if necessary, to file Form 990T and take the steps to pay the taxes from the IRA. We suggest working with a tax professional to help make this calculation.

UBTI

Unrelated Business Taxable Income (UBTI) occurs when a retirement account earns active business income, which is considered unrelated business income under federal tax law and is subject to its own tax.

If your IRA investments generate $1,000 or more of UBTI in a year, the IRA must pay tax on that income. Because the income is earned within a trust, UBTI is taxed at the trust tax rates. Although certain exclusions apply for income that includes interest, dividends, royalties, capital gains, and rents (if not debt-financed). See IRS publication 598 for additional details.

 

UDFI

Unrelated Debt-Financed Income (UDFI) occurs when a retirement account owns a real estate property that is debt-financed (with a non-recourse promissory note) and the property generates income.

The amount of income classified as UDFI is proportionate to the debt owed on the property. As the debt is paid down, the percentage of income that is taxable decreases. If the IRA sells the property and there is any debt during the preceding 12-months, a percentage of the gain will be taxable as UDFI.

 

View our Quick Guide to UBTI/UDFI for more in-depth information.

IRS Requires Annual FMV Updates

The IRS requires that all IRA assets be valued annually to satisfy the administrative and reporting requirements for IRAs (e.g., Fair Market Value Statement, also referred to as FMV). Valuations are also needed any time there is a major change in asset value, or prior to a taxable event such as:

»Taking a distribution of an asset in-kind

»Converting or recharacterizing an asset

»Transfering an asset in an account to beneficiaries

Depending on the type of asset held by your IRA, the valuation may be provided by the investment issuer to their IRA custodian [STRATA] in time to complete reporting on the year-end statement. If the investment issuer is unable or unwilling to provide valuation, or if directly-owned real estate is held, IRA account owners may need to engage a qualified independent third party or a certified real estate appraiser. Documentation supporting the valuation may be required.

You can find answers to our most common FMV questions here. 


Tips for Submitting an FMV

The IRA owner's opinion of value is NOT sufficient for federal reporting requirements. FMV's must come from an independent third-party who can determine the value using a method that complies with Revenue Ruling 59-60, or in the case of directly-owned real estate, a property appraiser.

Tax documents such as K-1's and appraisal district documentation DO NOT meet state/federal reporting requirements.

Allow plenty of time to submit the paperwork. Some alternative assets are challenging and valuations may take longer to determine. Fair Market Valuations must be received by the custodian in time to report on IRS Form 5498.

For STRATA account holders, an FMV request is sent in February for an updated FMV as of the prior December 31. If the FMV is not submitted in good order by the deadline, late fees may apply. We understand that some assets may have unique circumstances–so it's important to communicate this with STRATA in advance.

Investments must be registered as "STRATA Trust FBO [IRA Account Holder Name]" and a physical signature is required for documentation.

If you have questions, STRATA has resources available. Reach out to us at Service@StrataTrust.com.

Tax Forms Filed For You

IRA custodians are required to file certain reports with the IRS each year. It is important, even if you engage a professional to prepare your tax returns or assist with your investments, that you review the information reported on these forms to make certain they are accurate. Accuracy is critical because these forms are sent to the IRS and can affect your tax liability for the year. As a custodian, STRATA will file:

IRS Form 1099-R

This form reports any distributions taken as cash or in-kind assets during the previous year.

If you took money or investments out of your employer-sponsored retirement plan or IRA in the prior calendar year, you should receive a Form 1099-R from your retirement plan administrator or IRA custodian by January 31. Typically, you must include the value of your distribution in your taxable income for the tax year, although there are certain exceptions. The IRS will receive a copy of your Form 1099-R and will use it to match up the taxable income and tax liability you report on your tax return, so it’s important to review your Form 1099-R and understand the information it is conveying to the IRS.

A few of the key items you will find on this form include:

  • Box 1: Gross Distribution Amount – This is the total amount distributed before any income taxes are withheld. This box reports amounts distributed to you, as well as amounts that are directly rolled over, converted, or recharacterized.
  • Box 2a: Taxable Portion– Because IRA custodians do not keep track of an IRA owner’s nondeductible contributions, this box will generally report the same amount as the gross distribution amount for traditional, SEP, and SIMPLE IRAs. For Roth IRAs, Box 2a is generally left blank.
  • Box 4: Federal Income Tax Withheld – Any amount withheld and sent to the IRS as a prepayment of tax will be reported in this box.
  • Box 7: Distribution Code – An IRS distribution code identifies the reason for the distribution and alerts the IRS as to whether a distribution may be taxable or subject to the 10% early distribution penalty tax.

You can find answers to common FAQs and additional information on IRS Form 1099- R in our Insights Blog.

IRS Form 5498

This form reports the value of the IRA, as well as any contributions made for the previous year.

If you own an IRA (including an inherited IRA), you should receive an IRS Form 5498 every year that a reportable event took place. In addition to annual contributions made to Traditional and Roth IRAs, Form 5498 reports

  • Rollover contributions
  • SEP plan employer contributions
  • SIMPLE IRA plan employee and employer contributions
  • Recharacterized IRA contributions
  • Roth IRA conversion contributions
  • The fair market value of the IRA as of December 31 of the prior year
  • The value of certain types of alternative investments held within the IRA
  • Whether a required minimum distribution (RMD) is due for the year (the dollar amount may be included)
  • Repayments you have made of any qualified reservist distributions, qualified disaster distributions, coronavirus-related distributions, and qualified childbirth and adoption distributions

Because you can make IRA contributions until the tax filing deadline, the IRS requires the form following the deadline. Typically, your IRA custodian will send a copy to you and to the IRS by May 31 each year to report activity for the prior tax year.

You can find answers to common FAQs and additional information on IRS Form 5498 in our Insights Blog.

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