Converting Assets from a Traditional IRA to a Self-Directed Roth IRA

There are tremendous tax advantages Roth IRAs have over traditional IRAs causing investors to move assets from taxable accounts into tax-free Roth plans. These plans can be self-directed, gaining additional benefits and flexibility to those saving for retirement.

What are conversions?

The IRS allows you to move assets from a traditional IRA to a Roth account provided you are willing to pay the taxes due when the funds or assets are converted. Conversions are quite common each year, and most are performed with cash or securities, which are easily transferable. However, alternative assets held in a self-directed traditional IRA, like real estate, private notes and private placements, involve a little more legwork to get moved into a self-directed Roth account.

There are two main requirements that Advanta IRA needs to complete a conversion of assets held within a self-directed traditional IRA to a Roth account:

1. An updated valuation of the assets you wish to convert

2. Documentation you have prepared to properly transfer ownership of the assets from the traditional to the new Roth account

Obtaining Proper Valuation

When conversions occur, Advanta IRA must report the fair market value (FMV) of the assets to the IRS. The IRS definition of FMV is the price at which the asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts. (For additional guidance to determine FMV, see Internal Revenue Code 2512 and Department of Treasury Regulations 25.2512.1-6.)

When dealing in cash or securities that are publicly traded, the process is very simple—the custodian or administrator can simply look at the publicly traded markets to obtain a value on the day of the conversion. However, determining the true FMV of the many types of alternative investments permissible in self-directed accounts is not as clear-cut. In these cases, a qualified, independent third party should determine the FMV of the assets being converted.

Listed below are some commonly held alternative assets and the types of valuation that might be required:

Real estate—Have the property appraised by a qualified real estate appraiser around the time the conversion is to occur to obtain a timely FMV. Because the real estate market continuously fluctuates, the value reflected in an appraisal done in January can be substantially different from an appraisal performed in November. The appraisal must be paid with IRA funds as an expense.

Loans—In most cases, the FMV of a loan is equal to the outstanding principal plus any unpaid interest as of the date of the conversion. Other factors that can impact the FMV of a note include payment history and credit worthiness of the borrower, the interest rate in comparison to current market interest rates, and the underlying value of any collateral. If the loan’s FMV is not equal to the outstanding principal plus accrued interest, you should have an independent third party (perhaps an attorney, accountant, or appraiser) examine the payment history and terms of the note. This third party then provides the IRA administrator with the appropriate FMV to use in converting the loan.

Corporations, partnerships, and LLCs—For valuing an interest in a private placement entity in which the IRA is an investor, the manager, president, or other officer of the entity might be qualified to provide the FMV of the IRA holding. As with valuing real estate, the valuation date should be reasonably close in time to the conversion because the value of the entities could fluctuate and affect the value of the IRA’s interest.

For an interest in an entity in which an officer or manager is not qualified to provide the FMV, consult with a qualified, independent third party, such as a CPA or other business valuation expert to value the IRA’s interest within the LLC and possibly the value of the underlying assets in the LLC as well.

Foreign exchange (forex) and precious metals—Holdings in forex accounts and precious metals are easier than other assets to value because the value is tied to a public market. To convert a forex account, Advanta IRA requires a current statement on the day of the conversion because the value fluctuates on a daily basis. For precious metals, Advanta IRA uses the value as determined by the precious metals market.

Have questions?

If your IRA holds an asset that does not fall into the categories listed above, contact Advanta IRA for guidance on how to assess the value for conversion purposes and what type of documentation you need. In general, the valuation must be done by a qualified, independent third party.

Converting a traditional IRA and its assets to a Roth IRA is not a difficult process, but it is critical that the conversion is properly documented and that accurate valuations are obtained. If you have any questions, contact Advanta IRA so we can assist you in the process.

If you have questions about this article, or wish to learn more about self-directed IRAs and other accounts, please contact us.