by Mat Sorensen | Jan 15, 2019 | Real Estate & Alternative Asset Investing , Retirement & IRAs
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. They then 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. Last, 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 IRA’s 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 of 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. Call us at (888) 801-0010.
*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 | Dec 11, 2018 | Retirement & IRAs, Uncategorized
Roth IRAs can be established and funded for high-income earners by using what is known as the “back door” Roth IRA contribution method. Many high-income earners believe that they can’t contribute to a Roth IRA because they make too much money and/or because they participate in a company 401(k) plan. Fortunately, this isn’t true.
While direct contributions to a Roth IRA are limited to taxpayers with income in excess of $129,000 ($191,000 for married taxpayers), those whose income exceeds these amounts may make annual contributions to a non-deductible Traditional IRA and then convert those amounts over to a Roth IRA. Our IRA company – Directed IRA – can help those who want a self-directed “back door” Roth IRA, but the strategy can be done with almost anyone who wants a Roth IRA.
Examples
Here’s a few examples of earners who can establish and fund a Roth IRA:
- “I’m a high-income earner and work for a company who offers a company 401(k) plan. I contribute the maximum amount to that plan each year. Can I establish and fund a Roth IRA?” Yes, even though you are high-income, and even though you participate in a company 401(k) plan, you can establish and fund a Roth IRA. You just have to use the “back door” method.
- “I’m self-employed and earn over $200,000 a year; can I have a Roth IRA? Isn’t my income too high?” Yes, you can contribute to a Roth IRA despite having income that exceeds the Roth IRA income contribution limits of $191,000 for married taxpayers and $129,000 for single taxpayers. You just have to use the “back door” method.
The Process
The strategy used by high-income earners to make Roth IRA contributions involves the deposit of non-deductible contributions to a Traditional IRA, and then converting those funds in the non-deductible Traditional IRA to a Roth IRA. This is often times referred to as a “back door” Roth IRA. In the end, you don’t get a tax deduction on the amounts contributed, but the funds are held in a Roth IRA and are tax-free upon retirement (just like a Roth IRA). Here’s how it works:
Step 1: Fund a new non-deductible Traditional IRA.
This IRA is “non-deductible” because high-income earners who participate in a company retirement plan (or who has a spouse who does) can’t also make “deductible” contributions to an IRA. However, the account can be funded by non-deductible amounts up to the IRA annual contribution amounts of $5,500 for 2018 ($6,000 for 2019 and forward). The non-deductible contributions mean you don’t get a tax deduction on the amounts contributed to the Traditional IRA. Don’t worry about having non-deductible contributions though, as you’re converting to a Roth IRA, so you don’t want a deduction for the funds contributed. If you did get a deduction for the contribution, you’d have to pay taxes on the amounts later converted to Roth. You’ll need to file IRS form 8606 for the tax year in which you made the non-deductible IRA contributions. The form can be found here.
If you’re a high-income earner and you don’t have a company-based retirement plan (or a spouse with one), then you simply establish a standard deductible Traditional IRA, as there is no high-income contribution limit on Traditional IRAs when you don’t participate in a company plan.
Step 2: Convert the non-deductible Traditional IRA funds to a Roth IRA.
In 2010, the limitations on Roth IRA conversions, which previously restricted Roth IRA conversions for high-income earners, was removed. As a result, all taxpayers are able to covert traditional IRA funds to Roth IRAs since 2010. It was in 2010 that this “back door” Roth IRA contribution strategy was first utilized as it relied on the ability to convert funds from Traditional to Roth. It has been used by tens of thousands of Americans since.
If you have other existing Traditional IRAs, then the tax treatment of your conversion to Roth becomes a little more complicated as you must take into account those existing IRA funds when undertaking a conversion (including SEP and SIMPLE IRAs). If the only IRA you have is the non-deductible IRA, then the conversion is easy because you convert the entire non-deductible IRA amount over to Roth with no tax on the conversion. Remember, you didn’t get a deduction into the non-deductible Traditional IRA so there is not tax to apply on conversions. On the other hand, if you have an existing IRA with $95,000, and you have $5,000 in non-deductible Traditional IRA contributions in another account that you wish to convert to Roth, then the IRS requires you to convert your IRA funds in equal parts deductible (the $95K bucket) and non-deductible amounts (the new $5k) based on the money you have in all Traditional IRAs. So, if you wanted to convert $10,000, then you’d have to convert $9,500 (95%) of your deductible bucket, which portion of conversion is subject to tax, and $500 of you non-deductible bucket, which isn’t subject to tax upon once converted. Consequently, the “back door” Roth IRA isn’t well suited when you have existing Traditional IRAs that contain deductible contributions and earnings from those sums.
There are two workarounds to this Roth IRA conversion problem, and both revolve around moving the existing Traditional IRA funds into a 401(k) or other employer-based plan as employer plan funds are not considered when determining what portions of the Traditional IRAs are subject to tax on conversion (the deductible and the non-deductible). If you participate in an existing company 401(k) plan, then you may rollover your Traditional IRA funds into that 401(k) plan. Most 401(k) plans allow for this rollover from IRA to 401(k), so long as you are still employed by that company. If you are self-employed, you may establish a Solo or owner-only 401(k) plan, and rollover your Traditional IRA into this 401(k). In the end though, if you can’t roll out existing Traditional IRA funds into a 401(k), then the “back door” Roth IRA is going to cause some tax repercussions, as you also have to convert a portion of the existing Traditional IRA funds, which will cause taxes upon conversion. Taxes on conversion aren’t “the end of the world” though, as all of the money that comes out of that Traditional IRA would be subject to tax at some point in time. The only issue is it causes a big tax bill, so plan carefully.
The bottom line is that Roth IRAs can be established and funded by high-income earners. Don’t consider yourself “left out” on one of the greatest tax strategies offered to Americans: The Roth IRA.
by Mat Sorensen | Nov 6, 2018 | Retirement & IRAs, Uncategorized
Late last week, the IRS announced increased contribution limits for IRAs, 401(k)s and other retirement plans. IRAs have been stuck at $5,500 since 2013, but are finally moving up to $6,000 starting in 2019. If you save in a 401(k), including a Solo K, the good news is that your contribution limits were increased too, with employee contributions increasing from $18,500 to $19,000 and total 401(k) contributions (employee and employer) reaching $56,000. The IRS announcement and additional details can be found here.
Health savings account (HSA) owners also won a small victory with individual contribution maximums increasing by $50 to $3,500, and family contribution amounts increasing by $100 to $7,000.
Breakdown
Here’s a quick breakdown on the changes:
- IRA contribution limitations (Roth and Traditional) increased from $5,500 to $6,000, and there is still the $1,000 catch-up amount for those 50 and older.
- 401(k) contributions also increased for employees and employers: Employee contribution limitations increased from $18,500 to $19,000 for 2019. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $55,000 to $56,000 ($62,000 for those 50 and older).
- HSA contribution limits increased from $3,450 for individuals and $6,900 for families to $3,500 for individuals and $7,000 for families.
These accounts provide advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, tax deferred growth, or tax-free income, you should be using one or all of these account types. Keep in mind there are qualifications and phase out rules that apply, so make sure you’re getting competent advice about which accounts should be set up in your specific situation. Lastly, remember, all of these accounts can be self-directed and invested into assets you know best.
by Mat Sorensen | Sep 26, 2018 | Retirement & IRAs, Uncategorized
You have a n
umber of options and decisions to make when moving funds from a retirement account (401(k), 403(b), IRA) to an IRA. And you’ve got to be careful because sometimes checking the wrong box on your transfer, rollover, and withdrawal forms can have drastic tax consequences. For example, should you move funds from one retirement account to your IRA using a Direct Rollover, a 60-Day Rollover, or a Trustee-to-Trustee transfer? Which box do you check on your form and does a 1099-R get issued and reported to the IRS? Will I have to report anything on my tax return? Let’s go over the options and the consequences as well as the tax reporting for each one.
1. Direct Rollover from 401(k) to IRA – When Moving from an Employer Plan
A Direct Rollover is generally used when moving funds from an employer plan (e.g. former employer 401(k) or 403(b)) to an IRA). Under a direct rollover, the retirement plan administrator will send the retirement plan funds directly to the new custodian of your IRA. There is no tax consequence and there is no withholding. There is simply a “direct” rollover of the funds to the new IRA account. Most employer plans like 401(k)s and 403(b)s are traditional accounts, so those funds are generally rolled to a traditional IRA. If you are moving the funds to a Roth IRA, which is possible, you will need to covert the funds with the IRA custodian as they are being rolled into a Roth IRA. And of course, there are taxes due from the Roth conversion.
There are no limits on the number of Direct Rollovers you may complete, except as may be reasonably imposed by your employer’s retirement plan. For example, some employer plans may say that it’s an all or nothing option if you want to move funds once you no longer work there (e.g. keep all your funds there or move everything to an IRA).
If you are currently employed with your employer, you are usually only allowed to move funds from the employer’s plan when you have reached retirement plan age under the plan. This is usually 55 or 59 1/2 depending on your employer’s plan.
A direct rollover from an employer plan is not subject to tax or withholding. When a direct rollover is completed, a 1099 is generally issued from the current plan, but is marked as “not taxable” as the funds are being sent to another qualifying retirement account.
2. 60-Day Rollover – Only When You Need It This Way
A 60-Day Rollover allows you to take a distribution from one IRA, so long as you re-deposit that same amount into another IRA within 60 days, and the funds no longer considered distributed. When using a 60-Day Rollover, you receive the funds personally from the current IRA plan custodian, and then re-deposit those funds into a qualifying IRA within 60 days. Failure to re-deposit in time will cause a distribution of the funds, and you will be subject to taxes on any applicable penalties (e.g. early withdrawal penalty if under 59 1/2) for failure to re-deposit in time. There are no extensions, and there is no mercy if you miss the 60-day deadline. The new IRA custodian will generally require a certification, and your prior IRA account custodian’s statement to verify that the funds were in an IRA within the past 60 days.
It is very important to note that as of 2013 you can only complete one 60-Day Rollover every twelve months. See my prior article here on the 12-month rule for 60-Day Rollovers. Consequently, you should not use the 60-Day Rollover method option on a regular basis.
When using a 60-Day Rollover, the former IRA custodian will issue a 1099-R reporting the distribution as taxable and you will need to certify that you re-deposited within 60 days on your personal tax return to avoid the distribution. The 60-Day Rollover is communicated to the IRS on your personal tax return on line 15 where you report the distribution from the 1099-R, and then on line 15b you report that it was not taxable, since it was rolled over within 60 days. On line 15b, you indicate that the taxable amount is zero and you write the word Rollover next to line 15b. See the IRS instructions for line 15 here.
3. Trustee-to-Trustee Transfer – the Best Option When Changing IRA Custodians
The Trustee-to-Trustee transfer is the preferred method of moving funds from one IRA to another (e.g. from a Roth IRA at Fidelity to a Roth IRA with a self-directed custodian). Under a Trustee-to-Trustee transfer, the funds are sent from one IRA custodian (partial or full account) to your new IRA custodian. There is no tax, withholding, or penalty for moving funds via a Trustee-to-Trustee transfer, and there is no limit on the amount of Trustee-to-Trustee transfers you may complete.
A 1099-R is not issued when a Trustee-to-Trustee transfer occurs, and there is no withholding or tax due. Consequently, the Trustee-to-Trustee transfer is the preferred method to use when moving funds from one IRA to another.
by Mat Sorensen | Sep 4, 2018 | Retirement & IRAs, Uncategorized
Many self-directed IRA investors use an IRA/LLC to make and hold their self-directed IRA investments. In essence, an IRA/LLC (aka “checkbook-controlled IRA”) is an LLC owned 100% by an IRA. For a summary and description of an IRA/LLC, please refer to my video here. While most self-directed investors are using the IRA/LLC to invest in real estate or other non-publicly traded assets, there are many instances where an IRA/LLC owner would like to invest the cash from their IRA/LLC checking account into stocks or other publicly-traded investments. This may arise with portions of cash that are not yet large enough to make a desired self-directed investment, or when the IRA/LLC is between investments, such as after the sale of an asset or investment and before a new self-directed investment may be found. Or, it could simply arise because the account owner finds a publicly traded opportunity that they would like to pursue using the IRA/LLC account funds and structure.
I. Can My IRA/LLC Establish a Brokerage Account to Buy Stocks?
Yes, an IRA/LLC may have a brokerage account to buy stocks or other publicly traded assets. This account must be established in the name of the LLC. The brokerage account cannot have a margin account whereby account trades on credit. A margin account typically requires the personal guarantee of the underlying IRA/LLC owner, and this would amount to an extension of credit prohibited transaction. Additionally, any profits due from the trading on credit, even if you could get around a personal guarantee, would be subject to unrelated business income tax (UBIT).
II. What Are the Pros and Cons of Having a Brokerage Account with an IRA/LLC That I Should Know About?
1. Pro
Uninvested or accumulating cash from an income producing asset often times sit without earning any income in an IRA/LLC. By having a brokerage account with an IRA/LLC, the cash could be invested into stocks or other publicly traded investments, but could still be somewhat liquid in the event that funds are needed for a self-directed investment.
2. Con
Most brokerage firms do not have a specific account option for IRA/LLCs. As a result, most brokerage firms will simply treat the brokerage account as an LLC brokerage account. The problem with this is that they will send the IRS and your LLC tax reporting via IRS From 1099-B for trading income. While I’ve had many clients receive and ignore this, because the LLC is owned by their IRA, it does raise concern of an IRS audit for failure to report the 1099-B.
3. Potential Solution
Establish a business brokerage account in the name of the LLC but don’t get a margin account. We have seen clients use E-Trade and Interactive Brokers successfully for this. TD Ameritrade used to offer a specific IRA/LLC brokerage account but now requires customers to just establish an IRA with them instead.
III. What are the Options?
A second option to establishing a brokerage account with your IRA/LLC is to simply return funds from the LLC back to the self-directed IRA. This is not taxable. It is a return of investment funds or profits to the IRA. Then transfer funds from the self-directed IRA to a brokerage IRA as a trustee-to-trustee transfer. This is also not taxable. Now, you can buy stocks with the IRA funds in the brokerage account. When you would like the funds back in the IRA/LLC for a self-directed investment, you would send funds from the brokerage IRA back to the self-directed IRA as a trustee-to-trustee transfer, and would then invest the funds from the self-directed IRA to the IRA/LLC. While this involves more steps, its cleaner in the end as the brokerage IRA will be set-up with no tax reporting to the IRS on trading income. In the end, both options are viable, but self-directed investors should understand the differences and requirements for each option before proceeding with a brokerage account with their IRA/LLC funds.
by Mat Sorensen | Feb 27, 2018 | Retirement & IRAs, Uncategorized
All retirement account owners must be familiar with the required minimum distribution (“RMD”) rules applicable to their accounts. These rules require you, in most instances, to take partial distributions from your retirement account when you reach age 70 ½. And, surprise, the rules for Traditional IRAs, Roth IRAs, and 401(k)s differ. In fact, even 401(k)s where you are a 5% or greater owner have different rules than 401(k)s where you aren’t an owner. Thanks, Congress.
So what rules apply to Solo 401(k) owners? Well, generally speaking, you must begin taking distributions from your Solo K when you reach age 70 ½. Despite what you may think or presume, there are three quirks to be aware of when it comes to RMD and Solo 401(k):
Still Working Exception Does Not Work on Solo Ks
There is a general RMD 401(k) rule which states that even after age 70 ½, you are not required to take distributions from an employer 401(k) when you are still working for that employer. However, this exception does not apply to account holders or their spouses who own 5% or more of the company. In other words, business owners who use a Solo 401(k) will be forced to take RMD from their Solo 401(k) after age 70 ½ even if they are still working in the business.
Roth 401(k) Funds are Subject to RMD
RMD applies to Roth 401(k)s. I know what you’re thinking, “Wait, but why would RMDs apply to Roth 401(k)s when Roth IRAs are exempt?” Because Congress said so. I know, it doesn’t make much sense, Roth 401(k) distributions at retirement will be tax-free, like Roth IRA distributions, and the IRS will not receive any revenue from the distribution so why treat Roth 401(k)’s differently? There’s not a good answer, but you should write your Congressperson or Senator and ask. In the meantime, if you’re 70 ½ and you have funds in a Roth 401(k) which you don’t want distributed, you can roll those Roth 401(k) funds out to a Roth IRA and you can avoid the distribution requirement by letting those funds sit in your Roth IRA where no RMD is required. Checkmate, IRS.
Every 401(k) Must Have RMD Taken, No Aggregating
Every 401(k) account you have must take RMD. So, for example, if you have a Solo 401(k) and a 401(k) account with an old employer then you need to take RMD from each 401(k) account. You cannot aggregate those accounts together and take RMD out of one to satisfy both RMD requirements. This aggregating is allowed in Traditional IRAs but unfortunately does not work with different 401(k) plan accounts. If taking RMDs from multiple accounts is getting too complex, you can roll the old employer 401(k) to the Solo K or to a Traditional IRA (or Roth IRA if Roth 401(k) funds) to consolidate your accounts and your RMD requirements.
Make sure take RMD when you are required to do so. Failure to take RMD results in a 50% penalty tax on the amount you failed to take. As a result, it’s critical that you understand the RMD rules for each retirement account you hold. If you have made a mistake though, the IRS does have penalty waiver programs whereby you can correct some failed RMDs and request a waiver of the penalty due. This doesn’t work in every instance, but if you’ve failed to take RMD ask your tax lawyer or accountant on whether a penalty waiver could apply in your instance.
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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. They then 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. Last, 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.
