In 2010, regardless of your income, you can convert your traditional IRA assets to Roth IRA assets. Under the current law, you cannot convert a traditional IRA to a Roth if your adjusted gross income (AGI) exceeds $100,000. If any of your assets are currently undervalued, 2010 could be a great opportunity to convert your funds. The  assets will be taxed based on their fair market value as of December 31, 2010, and you also have the option of paying your tax bill over two years. You can pay the tax with cash outside of the IRA, which preserves your IRA assets. After the tax is paid, your earnings will never be taxed again.

Roth IRAs offer the added benefit that there are no required distributions. Unlike a traditional IRA, which requires that you begin taking minimum distributions starting at age 70½, with a Roth, you can let your assets sit and continue to grow. In a time when people work longer, you can amass wealth in a non-taxed environment for as long as you want.

Because you can convert as much or as little of your IRA as you want, you can choose to convert only the assets that have a current low value but that you anticipate having more value in the future. For example, if your self-directed IRA has real property that has been decreasing in value in today’s market but you expect a turnaround, that asset may be ideal to convert at the current fair market value.

This is the definition adopted for purposes of valuing charitable contributions of property,pension plan assets,and real property interests disposed of by nonresident aliens and foreign corporations.The courts have also followed this definition when addressing tax issues.

You must determine the fair market value before converting your traditional, pre-taxed assets to Roth, post-taxed assets. This value is used to compute the federal tax, and possibly state tax, that you owe. The best way to establish the fair market value is through a qualified appraiser. The appraiser must have an arms-length relationship with the taxpayer and the asset. The IRS might also accept a recent bona fide offer from a third party who is not considered disqualified under IRS regulations involving IRAs and qualified retirement plans.

Debt-financed assets, such as real estate, must be valued at net asset value. This means that the fair market value subtracts the amount of debt remaining after the date of the appraisal or valuation. Private placements should be assessed by persons or firms qualified to make such appraisals. Cash, stocks and bonds, and publicly traded assets use the established values on the date required for valuation.

After you have converted the asset, you can withdraw all or part of it at any time without paying federal taxes if you are at least 59½ years old. However, you may owe state tax. States differ on how assets in IRAs are taxed, and you should make sure that your have adhered to your state’s tax requirements.

The biggest question you have to think about is how well is your crystal ball working; how well can you and your tax advisors foretell your economic and tax-paying future?
Clearly, the more flexibility that you have and the more time that you have will give you more opportunity for appreciation and improve the possibility of the conversion paying for itself. But if past history and inflationary pressures are any indication, if , for example, your real estate investment is valued at 35% less than when your IRA purchased it, the increase in value over time should not only make up the 35% but even more. So converting now at its lowest fair market value may be a wise investment.

Your cost of living may also increase at a nominal annual rate of 3.5%, based on current rates. That means you have to make up the difference between the fair market value of the property and what your real cost of living is on the amount that you need to live on, or $199,000. In this scenario, you need the property to appreciate to at least $306,000. Tax on $306,000 is $107,000, leaving you with the $199,000 that you need to just break even with the original fair market value. So in this case, you hope for either better appreciation or lower taxes.

The income on the property also plays a big role over time. Let’s say that your property has a 7% net operating income annually. Over 20 years, that equals about $314,000. You also invest the income in money markets that make 4%, adding another $15,000. So when you add your $329,000 in income over 20 years to the fair market value of $306,000, you end up with an IRA worth $635,000! Tax on a distribution of $635,000 at the rate of 35% is about $222,000, leaving you with $413,000, a little more than twice as much than the IRA had in real dollar terms.

If you had paid the tax with money outside the IRA in 2010, you would pay $35,000 (35%) on the $100,000 fair market value. Taking into account how much you could have made on the tax you paid in 2010 over 20 years-we’re using 14.8% compounded annually, which totals about $553,000-and adding that to the $413,000 in the above scenario, your IRA is valued at nearly $628,000 ($996,000 taxed at 35%) rather than $635,000. But that money does not get taxed on distribution. You end up with $628,000 and not $413,000.