Roth IRA Valuation Discounts
Valuation discounts are common in FLPs for minority interests, lack of transferability , illiquidity, etc. In connection with the conversion of a regular IRA to a Roth IRA, may such discounts be considered in determining the value of the IRA to compute the tax on conversion? If so, what valuation discount metrics would be applicable? Finally, what are the steps to report the discounted valuation? Is the custodian a party to the valuation process?
I appreciate your assistance.
Permalink Submitted by Al Fry on Mon, 2010-01-18 16:56
I am fairly sure valuation discounts are not allowed in IRAs. Perhaps Alan, Mary Kay or Bruce has a PLR cite.
Permalink Submitted by louis rogers on Mon, 2010-01-18 17:09
A cite would be appreciated. Thanks!
Permalink Submitted by Alan Spross on Mon, 2010-01-18 17:30
To backtrack from the basic question, holding an FLP in an IRA presents challenges to the prohibited transaction rules due to the way “family member” is defined relative to those who own the 50% majority interests. Note the attached paragraph copied from an article on prohibited transactions.
>>>>>>>>>>>>>>>>>>>>>>
Prohibited Transactions: The standard
prohibited transaction rules apply to
limited partnerships. The investment
must be scrutinized prior to purchase to
verify that the transaction is not with a
disqualified person and does not constitute
self-dealing. FLPs deserve special
scrutiny in this area because they involve
the IRA’s purchasing an interest in a
partnership that is entirely owned by the
IRA grantor’s family members. Many attorneys
rely on Swanson v. Commissioner17
to establish that buying an FLP
is not a prohibited transaction. If the
IRA trustee is inclined to allow an IRA
to purchase an interest in an FLP, it is
strongly recommended that the IRA
grantor or the IRA trustee obtain a written
opinion from the attorney stating
that the transaction is not prohibited
under Code Sections 4975 and 408.
>>>>>>>>>>>>>>>>>>>>>>>>>>.
If that hurdle is passed, then the valuation must by done by an arms length party from any of the FLP members. Has the IRA custodian offered their opinion on these issues since the custodian by allowing these investments must specialize in this area?
You may also want to look into the Swanson v. Commissioner case (1996) to see if it touches on appraisal issues.
Permalink Submitted by louis rogers on Mon, 2010-01-18 18:28
Assume there are no prohibited transactions, self-dealing, etc., what is the authority for a valuation discount when making a Roth IRA conversion?
Is a third party valuation mandatory?
The custodians typically don’t want to get involved; they are not interested in valuation issues and tend to prefer a check the box approach to all issues.
Thanks!
Permalink Submitted by Al Fry on Mon, 2010-01-18 18:37
I thought the FLP was just an analogy. Is it holding the IRA, or is the IRA invested in an FLP?
Permalink Submitted by louis rogers on Mon, 2010-01-18 19:11
There is no FLP; just using the analogy of a valuation discount in a FLP. Please read from the beginning of the thread.
The question relates to a Roth conversion. Is there a legal basis for a valuation discount in making a Roth conversion (I am simply using the FLP as an area in which discounts may be recognized)? If so, what are the logistics to claim the discount in computing the tax on conversion?
THANKS!
Permalink Submitted by mk foss on Mon, 2010-01-18 19:28
Up until this time I’ve never seen anything explicit about valuation discounts in connection with Roth conversions.
There have been rulings and Tax Court cases that denied valuation discounts for estate tax purposes for retirement assets. The theory behind the discounts was that an asset that is subject to ordinary income taxes is less valuable than one that has the tax paid. See Estate of Smith vs. U.S. for example (fifth circuit case 11/15/04).
Restricted Management Accounts is another technique to reduce the value of retirement plan assets for estate tax purposes and for purposes of calculating RMDs. In Rev. Rul 2008-35, IRS concluded that no discount was available for restrictions imposed by an RMA agreement.
Self-directed IRAs that hold partnership interests, undivided interests in real estate, etc. often request that the IRA owner obtain an appraisal annually for those assets. If that appraisal contained discounts, custodians would probably use it. They also would require (I believe) the owner to agree to hold them harmless from any tax or other problems caused by the appraisal. The next logical step would be that an appraisal used for a year-end valuation would also be used for a Roth conversion. The problem has not presented itself in a way that IRS has ruled on it, to my knowledge. Since they’ve quashed all other attempts to use discounts in connection with retirement assets, they may not go for discounts in the Roth conversions.
Permalink Submitted by louis rogers on Mon, 2010-01-18 20:01
That is very helpful. Thank you!
Permalink Submitted by Bruce Steiner on Mon, 2010-01-18 21:16
As Mary Kay pointed out, before agreeing to allow the IRA to invest in an asset other than publicly traded securities, the custodian will probably require the IRA owner to obtain annual valuations.
I am not aware of any authority for valuing assets in an IRA differently from the way the same assets would otherwise be valued.
As Alan pointed out, the prohibited transaction rules are complicated, and can often arise in the context of investment in assets other than publicly traded securities. But it’s certainly possible to invest in other types of asset without running afoul of the prohibited transaction rules.
You may want to discuss the specific facts with your attorney.
Permalink Submitted by Greg Bien on Mon, 2013-03-25 00:25
The last discussion on this topic was two years ago. Have there been any rulings or court decisions since? Also, does it make a difference if the iliquid minority interest is taken as a distribution rather than a conversion? I find nothing that indicates assets in an IRA would be valued differently than if they were outside the IRA.
Permalink Submitted by Alan - IRA critic on Mon, 2013-03-25 02:21
Nothing new I an aware of. I agree that valuation for distribution taxable income would not vary from valuation for conversions (which is just a taxable distribution) or valuation to determine RMDs.
Permalink Submitted by Bruce Steiner on Mon, 2013-03-25 02:39
I am not aware of anything recent on this. While most valuation cases involve estate and gift tax, some valuation cases involve income tax, such as charitable contributions. I am not aware of anything that would suggest that the value would be anything other than the fair market value. As others have pointed out, be careful not to run afoul of the prohibited transaction rules.