Retirement Account Asset Valuation Seeing Greater Scrutiny

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

Asset valuation is coming under greater scrutiny. It started with valuations used for calculating estate tax. IRS questioned valuation discounts used in many estates and was successful in many of these challenges.

Then came the housing crash, the market crash and the mortgage security problems in 2006 and beyond. As a result, the SEC (Securities and Exchange Commission) is now looking harder at how illiquid investments in alternative funds are being valued. According to a recent Wall Street Journal article, some fund managers artificially inflate the value of these assets when they are selling shares of the fund. Once the sales period is over, the value of the assets is then written down.

The principle generally used to value assets for tax purposes is what would the price be between a willing seller and a willing buyer. For publically traded stocks, bonds and mutual funds this is a readily determined number. For illiquid assets, the valuation can be open to interpretation and manipulation.

The scrutiny is now moving on to retirement accounts. IRS has created new reporting for IRA distributions and account balance reporting. The use of these codes is optional for the reporting of transactions done in 2014 and will be mandatory for transactions in 2015.

Form 1099-R
There is a new distribution code for use on this form. Code K has been created to report the “Distribution of IRA assets not having a readily available fair market value (FMV).” This will impact IRA account owners and beneficiaries who take a distribution in kind or who do a Roth IRA conversion of an illiquid (hard-to-value) asset.

IRS defines these assets as “stocks, short or long-term obligations, ownership interests in limited liability companies (LLCs), partnerships, trusts, or similar entities, not readily tradable on an established US or foreign securities market, real estate, or option contracts or similar products not offered for trade on an established US or foreign option exchange.”

Form 5498
There are two new boxes on this form.

Box 15a is for reporting the FMV of any hard-to-value assets in the IRA. This is in addition to reporting the total FMV of the entire account.

Box 15b will be used for codes to identify the type of illiquid asset held in the account.

The instructions for these forms state that the IRA custodian is responsible for reporting an accurate FMV for the IRA assets – (remember: you should have received the FMV of your IRA assets by the end of January). This has been problematic in the past. Many custodians never change the value of the asset from the initial value, even when notified that the asset is now worthless. In order to get an accurate valuation, IRA custodians may need to start using services that specialize in this area. The cost of that valuation will likely be passed on to the IRA account. It may be necessary to have the asset valued annually. This could be a significant cost to the IRA going forward.