IRS rules require annual reporting for IRA accounts that include the fair market valuation of the IRA’s holdings.
In a conventional IRA invested in stocks, bonds, and mutual funds, the IRA account custodian can simply look up the publicly available value of plan assets and obtain the necessary fair market value of the account.
In a self-directed Checkbook IRA that is invested in alternative assets the values are not readily available to the IRA custodian. It therefore becomes the responsibility of the IRA account holder to provide the custodian with a statement of fair market value for their IRA holdings.
Why is Valuation Required?
The IRS requires some basic reporting on an annual basis for all IRA accounts on form 5498. The form is a simple summary of the account that lists beginning of year value, end of year value, and any contributions, distributions, or plan-to-plan rollovers that have taken place during the current tax year.
This information is used for several purposes such as to validate the history of an IRA over time and corroborate what is reported on an individual’s personal return relative to their IRA contributions and distributions. Aggregate data is also used to inform the government about citizen’s retirement savings trends and guide policy decisions.
There are also several circumstances where IRA account value drives taxable events, such as when an account is subject to Required Minimum Distributions, when an investor is performing a Roth IRA conversion, or if a specific asset is being distributed from the IRA to the account holder in-kind.
When is Valuation Required?
Most self-directed IRA custodians require an annual valuation as of December 31st and expect reporting from clients by mid-January. This allows them to include the end of year value on your December account statement, which is often referred to as a “substitute 5498” as it includes all of the reported information. This timing also gives the custodian plenty of time to prepare and submit form 5498 to the IRS by the required due date.
There are some circumstances when an ad-hoc valuation must be provided to accompany a taxable event for the IRA. This would include the distribution of an asset from the IRA in-kind, or a Roth IRA conversion.
What Happens if I Don’t Report?
Some custodians will impose a penalty for late reporting of annual valuation.
If you fail to update the valuation for multiple years an institution may resign as custodian of your account. They must demonstrate to their state regulators that they are actively managing accounts and operating in a compliant fashion, and too many delinquent accounts can be problematic in this regard.
Don’t become a “zombie” account with your IRA custodian. It can have bad results.
Informal and Formal Valuations
The annual valuation reporting for most IRA accounts is informal in nature. The value is just a benchmark number for the account but has no tax implications. A reasonable estimate of value is therefore acceptable.
When the IRA account valuation is associated with a taxable event, then a more formal valuation is required. Formal valuations are required annually at year-end for accounts subject to Required Minimum Distributions. This includes any tax-deferred IRA where the account holder is over age 72, or a non-spousal inherited IRA where the original account holder passed on or before December 31st, 2019.
Formal valuations are also required when an asset is being distributed in-kind to the IRA account holder, or when a Roth IRA conversion is being performed.
An informal valuation can simply be reported by the IRA account holder who has used reasonable means to determine fair market value.
A formal valuation may require certification from a licensed professional such as a real estate appraiser, CPA, or attorney.
Reporting Policies Vary by Custodian
The tax code does not actually provide specific guidance relative to IRA valuation, other than the requirement to report.
As a result, the policies of each IRA custodian are derived from how their compliance officers interpret the law and guidance from their state regulators. Policies differ to some degree, so be sure you understand how your IRA custodian operates and what your reporting requirements are.
A guiding principal is Treasury Regulation § 20.2031-1(b), which states:
“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.”
How to Value Assets
Following are general guidelines for determining the value of commonly held investments in a self-directed IRA.
Informal: A real estate comparables report from a licensed realtor is the best option and widely accepted. Some custodians will accept tax-assessed value for undeveloped land or online valuations such as produced by Zillow or Redfin.
Formal: A current appraisal from a licensed professional. The definition of current varies, but less than 60 days should reliably be acceptable.
Performing Promissory Note
Informal & Formal: The open principal balance of the note plus any accrued and unpaid interest due.
Informal: A 3rd party value opinion from someone knowledgeable in the asset class such as a note broker or servicer.
Formal: A 3rd party value opinion from a licensed professional such as an appraiser, CPA, or attorney.
Informal & Formal: The spot price of a token as listed on a major exchange or index.
Private Placements & Funds – Asset Holdings
When investing in a private company or fund that is purely an asset holding vehicle, the value of the underlying assets is generally used. A balance sheet from the investment provider may suffice.
In the case of a formal valuation, a certified valuation from a licensed 3rd party may be required.
Private Placements & Funds – Operating Business
Valuation for an operating business is complex and is typically derived from earnings. A 3rd party opinion provided in the framework of IRS Revenue Ruling 59-60 should be utilized.
Cash and Other Easily Valued Assets
If an IRA holds cash, stocks, or other publicly traded assets, an account statement evidencing the holdings and value will be sufficient for valuation calculations.
How to Report
Check with your custodian to be sure you understand their reporting process and requirements.
Some custodians can facilitate online reporting for informal valuations but may require a paper form with the signature of a licensed professional to certify a formal valuation.
With a Checkbook IRA holding a single LLC or trust entity the sum value of the entity is sufficient some custodians. Other custodians may want a listing of the individual assets held within the LLC or trust.
It is important to understand reporting requirements and plan ahead so you can meet the appropriate reporting deadlines.
Formal appraisals or licensed certifications can take additional time, so be sure to build that lead time into your process.
If you are wanting to perform a Roth conversion prior to year-end, you will want to start well before December 1st.
Keep your eyes out for reminders from your IRA custodian around the 1st of December, but do not rely on that as those reminder emails could be going to your junk mail folder. A best practice is to put an event on your personal calendar reminding you to prepare your valuation, with enough lead time to obtain the necessary documentation suitable to your situation.