What are the valuation concerns when converting a traditional IRA that holds alternative assets to a Roth IRA?
The Internal Revenue Service (“IRS”) requires that the assets held in a traditional IRA be valued at the time of the IRA’s conversion into a Roth IRA. The amount of the conversion is generally considered taxable income in the year of the conversion. For alternative assets, a fair market value must be determined by a qualified, independent, third-party valuation expert. There are both risks and opportunities in determining the fair market value of alternative assets held by an IRA.
The amount of taxable income from a Roth conversion is based on the fair market value of the IRA assets subject to the conversion. The lower the fair market value, the lower the taxes due. In addition to arriving at an appropriate and supportable value for the entity being valued, a qualified valuation firm can determine the appropriate lack of control and lack of marketability discounts to apply to the ownership of an alternative asset. J&M has years of experience in valuing business enterprises as well as in determining and defending appropriate discounts, potentially saving the IRA holder thousands of dollars in taxes.
The IRS is keenly aware that Roth IRA conversions present an opportunity for their holders to avoid taxes through asset undervaluation. As such, the IRS requires that a written valuation report be prepared by a qualified, independent, third party valuation firm to document the fair market value of any alternative assets held by the IRA at the time of the conversion. The detailed, written valuation report should use standard valuation methodology that considers historical financial results, projections, market conditions and other factors in arriving at a fair market value for the alternative assets. In addition, the IRS may require prior years valuation reports to analyze the changes in value of hard to value assets in the years prior to the conversion. If the amounts reported on an income tax return are later adjusted by the IRS and a tax increase results, an additional penalty may apply. This penalty of up to 40% of the increase in tax is due in the case of substantial understatement of tax, substantial valuation misstatements, or negligence or disregard of rules or regulations.
Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Please consult your own tax advisor before engaging in any transaction.
