The primary reporting requirement for an IRA is Form 5498 which identifies the annual FMV (Fair Market Valuation) on the assets held by the IRA. In the case of a regular IRA (non-self-directed), this step is an easy “snapshot” of the account (e.g., stocks, mutual funds) that can be taken quickly and accurately.
In the case of a self-directed IRA LLC, it is the responsibility of the IRA LLC manager (probably you) to report the FMV of the IRA to the IRA custodian so they, in turn, can report that value to the IRS annually. Historically, with many self-directed custodians, this may be as easy as the IRA LLC account manager simply informing the custodian of the value.
It is important to note that even IF this was the only request that the custodian was making of you, as the Manager of the IRA LLC you must account and operate the plan in full compliance and expectation of the IRS. This would include the annual valuation of the assets of your IRA LLC, regardless of what the custodian asks for.
However, effective in 2015, the FMV process is going to be a bit more detailed as the IRS is imposing stricter FMV reporting requirements on custodians to provide a more meaningful FMV on assets that may be difficult to value.
The IRS has noted:
“New information-reporting requirements are proposed to apply to certain IRA investments with no readily available fair market value. Reportable investments may include:
• Nonpublicly traded stock.
• Partnership or [limited-liability] interests.
• Real estate, options.
• Other hard-to-value investments.”
So with this new ruling coming into play for 2015, all IRA custodians (especially self-directed IRA custodians) will be required to complete the form with hard-to-value assets. One would expect that IRAs could fall under some regulatory scrutiny. Let’s face it, FMV valuations are of utmost importance to the IRS when an individual is executing a Roth conversion or distributions from the plan (e.g., Required Minimum Distributions (RMDs)). It is totally understandable that the IRS wants to ensure they are receiving their tax receipts on these transactions.
How Could This Change SAVE You Money?
Now, as a side note: There may be an unplanned benefit with more detailed accounting of the FMV as it relates to Roth conversions and distributions. Has anyone thought about the possibility of your hard-t0-value IRA asset losing value? For example, if your self-directed IRA purchased real estate for $100,000 and then, unfortunately, lost $30,000 in fair market value, the correct FMV would be $70,000 on the IRA asset, and not $100,000.
While this seems like common sense, it may surprise you that some IRA custodians will NOT value an IRA for LESS than what it had as a beginning balance. Quite honestly, they may be concerned that without a full and credible FMV being executed, the value is not actually correct.
They could also be…greedy.
You see many self-directed IRA custodians receive fees from account values. If your IRA has legitimately lost value, their fees may be reduced if they reflected a new FMV that is lower. Understanding and correcting that could actually save you money in custodian fees.
So, What is FMV? (and we will keep it easy)
First, let’s keep a couple of concepts in mind:
- FMV is not some IRS form that tells you what assets are worth (you know that…asset valuation is typically made by appraisers)
- FMV values can be significantly different between States and areas of states (e.g., New York City vs. Omaha, NE; New York City vs. Syracuse, NY)
- FMV and Market Value (MV) are not the same and will not necessarily result in the same value on the same property being evaluated
In more simplistic terms, what is MV and what is FMV?
Market Value — In simple terms, Market Value is the value of an asset (e.g., real estate) on a specified date when a sale occurs between a seller and buyer. Think of this: if an asset was sold today, what would it sell for? What is the market value as of that date?
Fair Market Value — With FMV, there is an assumption that the asset is not being sold. However, for valuation purposes, what would be the value if there was a hypothetical sale. The IRS gives some clarification on FMV:
“In a profit-sharing, money purchase, or stock bonus plan, the assets’ valuation will determine a participant’s account value, and ultimately, a participant’s distribution. In a defined contribution plan, Revenue Ruling 80–155, 1980–1 C.B. 84 provides that since amounts allocated or distributed to a participant must be ascertainable, plans must value their trust investments at least once a year, on a specified date, and according to a method consistently followed and uniformly applied”
Treasury Regulations state (the following text specifically addresses estate valuation issues, but the same principal applies to the definition of a FMV):
The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property…..is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate.
It continues by noting:
Thus, in the case of an item of property…..which is generally obtained by the public in the retail market, the fair market value of such an item of property is the price at which the item or a comparable item would be sold at retail.
For example, in the case of shares of stock or bonds, such unit of property is generally a share of stock or a bond….Property shall not be returned at the value at which it is assessed for local tax purposes unless that value represents the fair market value as of the applicable valuation date. All relevant facts and elements of value as of the applicable valuation date shall be considered in every case.
The bottom line is that with the IRA LLC valuation, a credible value will need to be identified. The question that many people will practically ask is: If an IRA LLC has real estate within the plan, will due diligence dictate that an appraisal be executed on the property OR will a comparative analysis (comp) be acceptable? A more logical answer to that question may undoubtedly hinge on whether any distribution or Roth conversion is being executed for the plan. Let’s break that down a bit further:
Example: Jo is 40 years of age and is the manager of her IRA LLC. She has a $300,000 (value) IRA LLC in which she has two assets: a $200,000 piece of property and $100,000 (cash). Based on her age, Jo will not be taking any distributions from the plan and she is not executing a Roth conversion to her IRA. Since there are no concerns with either distributions or conversions, would the IRS find it acceptable that Jo secure a comparative analysis (comp) on the property from a licensed and competent realtor or would they require an appraisal. The hopeful thinking by many IRA LLC managers is that, in this example, a comp would suffice in establishing the FMV. Obviously, the property is not being sold (meets FMV standards) and no distributions/conversions are occurring.
Feel free to visit with your IRA custodian and inquire if they have been provided final instructions from the IRS on the proper completion and filing of Form 5498.