Today’s REI Classroom Lesson

Clay Malcolm joins us to share information regarding the new 5498 and how it impacts you and your IRA.

REI Classroom Summary

Make sure you’re aware of the facts and what the IRS will be able to see when discussing your IRA.

Listen to this REI Classroom Lesson

Real Estate Investing Classroom Show Transcripts:

Mike: Welcome back to the REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. Now, let’s meet today’s expert host.

Clay: Hi, everyone. My name is Clay Malcolm, and welcome to the REI Classroom. Today, we’re going to be talking about the new Form 5498 that came out from the IRS. A lot of people know that it may affect their IRA investing, but they may not know how. So we’re going to talk about that today.

Mike: This show is sponsored by

Clay: The IRS Form 5498 is a mechanism for the IRS to track your IRA’s investments. You are probably familiar with the fact that in order to get the tax benefits that are associated with an IRA account, like a traditional or a Roth, or even an HSA, you have to have a custodial entity as part of the equation. If you think about it from the IRS’ perspective, part of the reason that they require that is because those entities are audited by banking authorities, and so on and so forth.
So they’re bound to report accurately what’s going on in the IRA, and from an IRS perspective they’re tracking that money. They’re going to give you these tax benefits over any number of years. But they want to make sure that the ultimate tax event is according to the rules or what they think they should be getting, and so they’re tracking that money. Each year, every IRA custodial entity submits a Form 5498 for every IRA.
Now, IRAs started in the mid-1970s, and so at that time a 5498 basically said, “Such and such IRA is worth X dollars.” There really was not much differentiation in terms of what was in the IRA, what types of assets they had bought, so on and so forth. Now, the IRS could certainly track growth or decline of those assets, but it was very hard to tell what was in there.
With the advent of alternative assets in IRAs and that becoming more and more prominent, the IRS has had a little bit of trouble with valuations. Meaning that the value of the IRA is now dependent on things like real estate or a loan, or private equity, or things like that. They’re a little bit different to value than, say, publicly traded securities like stocks or mutual funds, or things like that.
Now, one of the things that has been occurring is that this year, and this is the 2015 tax year that has just transpired, this is the first year that it’s required for the 5498 to actually differentiate some of the assets, or categorize them, that are in the IRA. One of the reasons that that might be important for you is if the IRS ever wants to understand, or go in and look and kind of investigate a particular investment strategy.
So the categories are a little bit broad, but there’s one that’s real estate specific. It just says “real estate”, so if your IRA owns a rental property or a warehouse, or something like that, that’s where that category would fall. There are also ones for lending-based assets, as well as equity-based assets, and things like that. So if your real estate participation falls in one of those categories, that would also be reported.
Then, one of the things I think that is the most prevalent or gets the most airtime about it is certainly the checkbook control scenario, which is typically a single member LLC that’s owned by the IRA. The IRA holder is the manager and goes out and buys real estate, or any number of other assets. Because the IRA holder is actually writing checks on IRA money, occasionally they make a mistake. Whether that’s intentional or not, that’s another story.
But that investment strategy is something that the IRS is aware of in terms of it maybe not following the rules all the time, again, intentionally or unintentionally. So if the IRS ever decided to target any of those investment structures, they would have a lot more information about where to look than they used to. So from the 1970s up until the 2014 tax year, they would essentially be throwing a dart at a board trying to find a particular investment type. But starting this year, 2015 tax year, which is now being reported, it’s mid-2016 at this point, the IRS will have some information about the investment structures and the assets that are in there.
Nobody knows exactly what they’re going to do with this information. It might have no effect whatsoever, or it might have an effect. But it’s good to know if you’re an IRA investor, you want to make sure you have all the facts so that you can follow your own risk tolerance, make your decisions about what’s going on in your particular portfolio. Thanks for joining us on the REI Classroom, and happy investing.

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