The IRS Cracks Down On SDIRA Compliance

June 14, 2016

Robert Katz, CFP®


Investing IRA money in non-traditional assets

In order to comply with vehicle specific rules and IRS tax reporting requirements, traditional custodians often only allow “approved” investments to be held in an IRA; typically restricting investment options to publicly traded stocks, bonds, mutual funds, and CDs.

However, individual estate and income tax circumstances, as well as investment allocation considerations, may warrant holding certain non-traditional assets in a Self-Directed IRA (SDIRA).

SDIRAs are offered by ” passive” custodians and give the account holder maximum control over the investment options by shifting the burden of compliance from the custodian to the account owner. Investors often use these accounts to hold non- traditional assets not eligible to be held by a traditional IRA custodian such as real estate, closely held business entities, private notes or loans, and private investments.

What’s at-risk?

In order to maintain their tax-advantaged status, IRAs are subject to certain rules – the two rules most commonly violated in a SDIRA, or an IRA holding “hard-to-value” assets, are the following:

  • Minimum Distribution Requirements – failing to take a required minimum distribution (RMD) from an IRA may result in a 50% penalty on the amount that should have been taken.
  • Prohibited Transactions and Unrelated Business Taxable Income (UBTI)-certain transactions and investments are not permitted in IRAs and have the potential to invalidate the tax-deferred features of the account, which in-turn may create a massive and unexpected tax liability.

What’s changed?

The IRS is implementing new audit and enforcement tools intended to enhance reporting requirements and increase the amount of information it receives from IRA custodians and trustees in order to catch more mistakes and incidents of noncompliance.

  • Form 5498 – this form serves as an IRA “account summary” and is generated annually by the custodian for tax reporting. Recently, the IRS has changed the reporting requirements to include information regarding “hard-to- value” assets held in the account.
  • Form 1099-R – this form reports details around the distributions taken during the tax-year. A new part of the form reports distributions of assets that do not have readily determinable market values

With the new tax reporting rules, the IRS will be watching for common pitfalls and will likely be more aggressive than in the past in pursuing errors or incidents of noncompliance. SDIRAs are likely to be heavily scrutinized since there is limited custodian oversight and, therefore, a higher probability of error/noncompliance.

Finally – what do I do?!

If you hold alternative, private, illiquid, or hard-to-value assets in an IRA, now may be a good time to review your accounts with your tax advisor to ensure there are no unintended complexities that will leave you open to IRS scrutiny.

Contact Robert and/or Seth in our Wealth Strategies Group to schedule a review of your investment vehicles holding any nontraditional assets and learn more about the strategies we employ to address these issues and mitigate the risk of noncompliance on a case-by-case basis.

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