In the 1960’s television series “Lost in Space” the robot, who acts as a surrogate guardian for young Will Robinson, utters the phrase “Danger, Will Robinson! Danger!” when the boy is unaware of a pending threat in one episode. I was reminded of this classic phrase when I read about the new reporting requirements beginning in 2014 for self-directed IRAs. The new requirements, while optional for 2014, will likely become mandatory for 2015. So are these requirements and what do they mean for owners of self-directed IRAs?
Custodians are required to report to the IRS any distributions taken from IRAs. At the end of each year a Form 1099-R is sent to the IRS and to the IRA owner which reports the value of any distributions taken during the year, among other things. The distribution codes reported on Form 1099-R in box 7 indicate the type of distribution taken. The new reporting requirements add code K to the list of possible codes.
New code K is used to report distributions of IRA assets not having a readily available fair market value, including private stocks, short or long-term debt obligations, ownership interests in limited liability companies (LLCs), partnerships, trusts, or similar entities, real estate, and option contracts. Distribution code K will be used in conjunction with the distribution codes for premature or normal distributions from pre-tax accounts, such as traditional IRAs, conversions to a Roth IRA, death distributions to beneficiaries, and rollover distributions from an IRA into a qualified employer plan like a 401(k). With the use of these codes, it will be easier for the IRS to flag these transactions for audit to make sure an appropriate value was reported for taxation purposes. This increases the importance of accurately reporting the value of non-traditional assets which are converted or distributed from an IRA. Having an updated fair market value with good backup documentation of how the value was arrived at will be critical in the case of an audit. If the distribution is in the form of cash or assets having a readily available fair market value such as publicly-traded stocks, code K will not be used.
Form 1099-R is only used when a distribution or conversion from an IRA takes place. However, every IRA owner receives a Form 5498 which reports the annual contributions to the account and the fair market value of the assets at the end of the year. Beginning in 2014, new boxes 15a and 15b will be added to Form 5498 to report on those non-traditional assets held within the account that are generally “not traded on an established securities market.” Box 15a is used to report the fair market value of the non-traditional assets reported in Box 15b. There are special codes to indicate the type of non-traditional assets that are being held by the IRA. The new codes are: A – private stock; B – short or long-term debt obligations (for example, promissory notes); C – ownership interest in a limited liability company (LLC) or similar entity; D – real estate; E – ownership interest in a partnership, trust, or similar entity; F – option contracts; or G – other assets that do not have a readily available fair market value. Up to two codes may be in box 15b. If more than two types of the described assets are owned by the IRA, then the custodian will report code H. Like the addition of distribution code K to the 1099-R, the changes to the 5498 make it imperative that accurate fair market values of non-traditional assets with documentation of how the value was established are reported to the custodian each year.
The additional information on Form 5498 will allow the IRS to better understand what percentage of IRAs hold non-traditional assets, the purported fair market value of those assets, and what types of assets are held. This will enable the IRS to more efficiently allocate their audit resources. Even for those who diligently follow all of the rules, the prospect of raising the audit profile of self-directed IRAs is nerve-racking. Fortunately, for the vast majority of self-directed IRA owners, there truly is no danger from these new reporting requirements. However, there will likely be increased regulatory pressure to accurately report fair market values.
With the advent of the new reporting requirements in 2014 for self-directed IRAs, it is all the more important to work with knowledgeable custodians or administrators like Quest IRA, Inc. (www.QuestIRA.com). Learning the rules well enough to stay out of trouble and working with competent advisors is critical. Take advantage of all the FREE education and resources offered by Quest IRA. Good luck with your investing!
H. Quincy Long is a Certified IRA Services Professional (CISP) and an attorney. He is also President of Quest IRA, Inc. (www.QuestIRA.com), a self-directed IRA third party administrator with offices in Houston, Dallas, and Austin, Texas, and in Mason, Michigan. He may be reached by email at Quincy@QuestIRA.com. Nothing in this article is intended as tax, legal or investment advice.
© Copyright 2013 H. Quincy Long. All rights reserved.