Maggie Polisano, Co-Founder, CamaPlan Self-Directed IRA LLC
Every year, the IRS requires that you report an educated estimate of the value of all the assets in your tax-advantaged retirement accounts — IRA, 401(k), HSA and ESA. The report should reflect values as of December 31 of the tax year.
This valuation of assets is especially important if you are 72 or older and have a non-Roth IRA or 401k account. That’s because value of assets in your account form the basis for calculating your required minimum distributions (RMD), the amount you are required to withdraw each year now that you have reached the age of mandatory RMDs.
It’s easy to value the kinds of assets you find in a standard retirement account, such as cash, cash equivalents, and publicly-traded securities (stocks and bonds). For securities, simply look at their values reported by the public exchanges on which they are traded. Same goes for precious metals, which trade at exchanges all over the globe.
But owners of self-directed IRAs or Solo 401(k)s may have a harder time with certain assets for which these types of accounts were designed. These assets are not traded on public exchanges, so there’s no available independent reporting on their estimated value on any given day.
Examples include:
- Real estate equity (all types, from single family homes to apartment buildings, warehouses. office space and raw land)
- Real estate debt (mortgages, promissory notes and tax liens)
- Equity or debt investments in private companies that don’t trade on public markets.
So how do you submit an accurate value of these hard-to-value assets? What will the IRS accept? Let’s look at how to do it, one asset class at a time.
Real Estate Equity
Publicly traded REITs and real estate mutual funds are easy to value. Privately-held real estate, REITS, partnerships and funds are another matter. The value of these holdings are set by what a buyer on the open market is willing to pay for them. If you have not listed the property for sale recently, how do you determine its value?
Single-Family Homes, Townhomes and Condos
If the real estate is a single-family dwelling, you have an “easy out” for estimating its value. The IRS will accept three estimated values from a reputable real estate data aggregator.
You probably know some of the more popular companies in this niche — Zillow, Trulia, Realtor.com, Redfin, etc. Each of these companies tracks data on nearly every type of single family residential real estate in the country — even if it is not currently for sale.
They provide an up-to-the-minute estimate of the property’s value, based on data like recent sales of similar dwellings in the same neighborhood, city or town, and from property tax records. Zillow famously calls this a “Zestimate.”
As any good REALTOR will tell you, these estimates are not necessarily a completely reliable indicator of what the home will sell for, since estimates don’t take into account condition of the dwelling or the value of added amenities, such as a finished basement or remodeled kitchen. But as long as you submit estimates from three sources, the IRS will accept this as an estimate of the asset’s value for compliance with the terms of your retirement account.
If the IRA or 401(k) is only a partial owner of the property, take those three estimates and multiply them by your percentage ownership interest. For example, if your self-directed IRA holds a 25% interest in a property, you will report to the IRS the one quarter of the web estimates as the asset value within the IRA.
Harder-To-Value Properties
Commercial properties like multi-family dwellings, apartment complexes, office buildings, retail and mixed-use spaces, industrial facilities and real estate ventures in which the IRA or 401k is a participant don’t have as online estimates of value. The same goes for unique or hard-to-classify property, such as parcels of raw land or historic properties on the national register.
For real estate ventures in which the retirement account is a partial owner, the sponsor of the venture or general/operating partner usually issues some form of valuation, such as a K-1 or statement of net asset value, in the case of shares owned by the IRA or 401k. In the case of more directly-owned hard-to-value real estate equity interests, you may need to acquire an opinion of value from a licensed real estate appraiser or broker. Note that this doesn’t have to be a full-scale appraisal, with all the costs and burdens that come with it. It just needs to be a formal opinion of value by an established professional qualified to make such an appraisal.
The caveat is that the appraiser or broker you use has to be an independent third party, with no personal or business interest in the property other than being hired to opine on its value.
LLCs and Partnerships
If the retirement account has invested passively in a syndicated LLC or partnership, the sponsor of the syndication is required to submit Form K-1 to each passive investor. This tax form includes, among other things, the value of the investor’s ownership interest. The IRS will accept this form as validation of the asset value within the retirement account. Please note that the values declared on the K-1 may not take into account depreciation, so we always recommend seeking advice from your financial or tax specialist.
Real Estate Promissory Notes
If the IRA or 401(k) owns the mortgage note on real property, valuing this asset is usually fairly easy. The value is the principal balance owed, plus any accrued or unpaid interest. You probably have documentation of this. If the note is serviced by a third-party company, ask them for a statement. If all else fails, you can solicit the opinion of a third-party appraiser or qualified financial professional to estimate the value of the note. Since valuations are what a buyer would expect to pay at the time of the valuation, some notes are often sold at a discount, so the true valuation may be less that the unpaid balance and accrued or unpaid interest. Consult your financial or tax specialist
Private Equity
If the retirement account owns stock or some other equity interest in a private company — whose shares are not traded on a public stock exchange — there is no daily public statement of the value of that equity position. Sponsors or general partners of these types of investments usually provide estimated valuations, share prices or net asset values. In the absence of an independent audit, valuations like these should merit close inspection of the basis used for valuation. In the case of a poorly-supported opinion by the investment sponsors or operating/general partner, you should solicit the opinion of a third-party expert.
Who should that expert be? It depends on the size of the business and the industry. Certain accountants who specialize in the industry or type of business may be qualified to offer an opinion of value that the IRS will accept. You might also try a certified valuer or appraiser, a business advisor, business broker, or mergers-and-acquisitions specialist.
Private Debt
If you have loaned money to a private company or individual, the debt can be valued in similar fashion to a real estate promissory note. The value of the debt is the remaining principal balance left owing, plus any accrued or unpaid interest outstanding. If need be, a third-party appraiser, valuer, or business advisor can offer an expert opinion of the value of the debt which the IRS should accept.
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If you have a self-directed IRA or solo 401(k), reporting to the IRS the value of hard-to-value assets may feel like an extra layer of burden on top of an already burdensome relationship between you and the government.
But as many happy retirees can attest, the ability to control your retirement strategy and enjoy index-beating tax-deferred returns can make the extra hassle well worth it.
Some additional resources:
Fair Market Value (FMV): Definition and How to Calculate It (investopedia.com)
What Is Fair Market Value? (realtor.com)
What is Fair Market Value? (FMV Formula + Calculator) (wallstreetprep.com)
The preceding article is not intended as, nor should it be considered, advice of any kind. It for educational purposes only. Please consult qualified financial and tax specialists.
