Alternative Assets In A Self-Directed IRA
Every IRA custodian must annually report the fair market value of each IRA it holds to the Internal Revenue Service (IRS). The IRA custodian reports the fair market value of the IRA to the IRS using IRS Form 5498. Most IRA holders are unaware of this process. The majority of IRAs hold traditional assets, such as stocks and mutual funds. The IRA custodian will be able to calculate the value of the IRA itself. IRA custodians do this by using publicly available information as of December 31 of the previous year.
For example, if Ken Smith has an IRA with Trust Company X and owns 100 shares of Apple, Trust Company X can quickly calculate the value of the IRA based off the share price as of December 31. However, in the case of alternative assets, calculating the fair market value of the IRA investment may prove more difficult.
The Internal Revenue Code (IRC) does not describe what an IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits “disqualified persons” from engaging in certain types of transactions. The definition of a “disqualified person” has a variety of party scenarios. However, it typically includes:
- The IRA (individual retirement account) holder
- Ancestors or lineal descendants of the IRA holder
- Entities in which the IRA holder holds a controlling equity or management interest
Importance of IRS Form 5498
One of the main purposes of IRS Form 5498 is to give the IRS access to the annual valuation of IRA funds on an annual basis. IRA valuations are also necessary for in-kind distributions. In addition, required-minimum-distribution calculations are based on year-end IRA values. IRS Form 5498 also reports the total annual contributions to an IRA account. Additionally, it identifies the type of retirement account you have. This can be a traditional IRA, Roth IRA, SEP IRA or SIMPLE IRA. Form 5498 also lets the IRS know the amounts that you roll over or transfer from other types of retirement accounts into this IRA.
However, in order to address IRA valuation abuses, in 2013, the IRS proposed additional reporting requirements for hard-to-value IRA assets. This proposition is in both Form 5498 and Form 1099-R (for distributions). The new IRS Form 5498 reporting requirements are in place for 2015 and beyond.
The IRS states that the main purpose of this change is to get a better handle on valuations for distribution purposes for hard-to-value IRA assets. This includes real estate, but it offers the IRS with more insight than they have in terms of the type of assets investors purchase with retirement funds.
It is important that any IRA holder owning alternative assets, such as real estate, with a self-directed IRA or 401(k) plan, acquire an independent valuation of the asset for IRS Form 5498 purposes. This can be in the form of acquiring an independent valuation from a professional or expert in the market. It also includes tax assessment records from the county or state, or in some cases, a trusted online source. This is especially important if one is over the age of 70 1/2 and is subject to the required minimum distribution (“RMD”) rules. Also, it’s important if the individual is taking the asset as an in-kind taxable distribution. The value of the IRA asset(s) has a direct correlation on the amount of tax one will pay.