This article originally appeared on Forbes.com, written by our own Adam Bergman -
Every IRA custodian is required to report annually to the Internal Revenue Service (“IRS”) the fair market value of each IRA it holds. The IRA custodian will report the fair market value of the IRA to the IRS using IRS Form 5498. Most IRA holders are unaware of this process since the majority of IRAs are invested in traditional investments, such as stocks and mutual funds, and the IRA custodian will be able to calculate the value of the IRA itself using publicly available information as of December 31 of the previous year. For example, if Ken Smith has an IRA with Trust Company X and owns 100 shares of Apple, Trust Company X can quickly calculate the value of the IRA based off the share price as of December 31. However, in the case of alternative assets, such as real estate, private equity, tax liens, etc., calculating the fair market value of the IRA investment could prove more difficult.
The Internal Revenue Code does not describe what an IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits “disqualified persons” from engaging in certain types of transactions. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest.
One of the main purposes of IRS Form 5498 is to give the IRS access to the annual valuation of IRA funds on a year-to-year basis. IRA valuations are also needed for in-kind distributions and, in addition, required-minimum-distribution calculations are based on year-end IRA values. IRS Form 5498 also reports the total annual contributions to an IRA account and identifies the type of retirement account you have, such as a traditional IRA, Roth IRA, SEP IRA or SIMPLE IRA. Form 5498 also lets the IRS know the amounts that you roll over or transfer from other types of retirement accounts into this IRA.
However, in order to address IRA valuation abuses (as the IRS has viewed undervaluation as a potential problem) in 2013, the IRS proposed additional reporting requirements for hard-to-value IRA assets, on both Form 5498 and on Form 1099-R (for distributions). The new IRS Form 5498 reporting requirements are in place for 2015 and beyond.
The IRS has stated that the main purpose of this change is to get a better handle on valuations that are being used for distribution purposes for hard-to-value IRA assets, such as real estate, but it certainly will offer the IRS with more insight than they have right now in terms of the type of assets that are being purchased with retirement funds.
It is important that any IRA holder owning alternative assets, such as real estate, with a self-directed IRA or 401(k) plan, acquire an independent valuation of the asset for IRS Form 5498 purposes. This could be in the form of acquiring an independent valuation from a professional or expert in the market, tax assessment records from the county or state, or in some cases, a trusted online source. This is especially important if one is over the age of 70 1/2 and is subject to the required minimum distribution (“RMD”) rules or will be tking the asset as an in-kind taxable distribution as the value of the IRA asset(s) has a direct correlation on the amount of tax one will pay.