Does your IRA own any of the following asset types?
- Non-listed real estate investment trusts (REITs)
- Equipment leasing LPs
- Direct participation programs (DPPs)
- Delaware statutory trusts (DSTs)
- Private equity funds
- Limited partnership interests (<100%)
- Private company stock
- Trust deeds (DSTs)
- Thinly traded securities
- Structured notes
- Non-listed business development companies (BDCs)
- Oil & Gas LPs
- Tenants-in-common (TICs)
- Hedge funds
- Real estate (commercial, residential, land)
- Limited liability company interests (<100%)
- Promissory notes
- Private placements
- Collateralized mortgage obligations (CMOs)
- Other alternative assets
The result of IRA valuation errors can be severe. IRA owners who sustain a taxable event where the alternative assets are valued higher than Fair Market Value (FMV) incur more tax than necessary.
IRA owners who report a taxable event where the alternative assets are valued lower than FMV will owe additional tax plus penalties and interest. RMD calculations using inflated alternative asset values result in more money being forced out of the IRA annually and cause the IRA owner to report excess taxable income each year. RMDs calculated on alternative assets valued at less than FMV result in too little being withdrawn from the account which can result in hefty penalties on the amount not withdrawn.
These issues are very common in IRAs holding alternative assets such as those listed above. These assets are difficult to value properly since they often don’t trade on established exchanges and don’t have readily available share prices.
FMV is the required valuation to be used in all of the above reporting scenarios. FMV for tax reporting purposes is defined in the “willing buyer – willing seller” rule which states:
“The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
Appraisers determining FMV of an asset under this definition are required to consider things such as the illiquid nature of the alternative asset, the lack of trading markets, the inherent risk profile of the investment, the cost structure, and many other specific features.
Most IRA trustees/custodians report alternative assets at either the original purchase cost or the current value as reported by the asset sponsor. Sponsor provided values are generally net asset value (NAV) or some variation thereof. NAV is simply the total value of all the underlying assets in a particular investment vehicle (fund, limited partnership, LLC, etc.) divided by the number of shares of the investment vehicle held by investors. For example, an investment fund with total assets of $1000 and 100 shares held by investors has a NAV of $10 per share ($1000/100 shares = $10). This is also often called book value.
In the majority of cases, an investment may have a NAV and FMV which are completely different values. The appraiser begins with NAV and then applies valuation adjustments upward and downward to arrive at the proper FMV according to the definition shown above. Adjustments are applied for things such as illiquidity, lack of trading markets, unique positive opportunities for the investment, high or low risk profiles, time horizon, etc.
In either case, whether reported at original purchase price or current NAV, the value used is typically inconsistent with the FMV definition shown above as required for tax reporting. This means in many cases that IRA owners have the opportunity to correct the valuation mistakes and obtain tax refunds and/or reduce existing penalties depending on the specific circumstances. IRA owners should not assume the values reported for their alternative assets are correct under the tax reporting rules and should seek assistance in reviewing and correcting issues associated with such values.
Have you or your loved ones incurred any of the following events with an IRA?
- Required Minimum Distributions for IRA owners age 70 ½ and older (RMDs)
- Distribution of assets other than cash (in kind distributions)
- Roth conversions
- Estate valuation of IRAs at death
- Inherited IRA distributions (another type of RMD)
- Creditor actions (lawsuits or judgments against you)
- Penalties for failing to take RMD
- 10% early withdrawal penalties
- Series of substantially similar withdrawals (72t withdrawals)
KEEP IT! Advanced Tax Strategies for IRAs
by Joe Luby
Powerful ways to protect your IRA and keep your piece of the $10 trillion dollar pie!
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