Discuss your self-directed IRA taxes with your IRA custodian. Get the proper forms, report your IRA earnings, and leave no stone unturned.
It’s that time of year again when we scramble for our W-2s and report our yearly earnings in the hopes of a big tax return. However, tax time can be especially stressful if you are unsure of what you need to file to avoid a run-in with the IRS.
In addition to your gross income, investors need to be aware of their responsibilities regarding tax reporting on self-directed IRAs, including their Fair Market Value (FMV) of account.
Therefore, if you own an SDIRA, it is crucial to perform your due diligence and see that you and your custodian complete the proper items to reap the full benefit of your investments.
If you are still determining what steps are necessary to report taxes for your self-directed IRA, here are a few helpful tips.
IRA Custodian Responsibilities:
The primary responsibility of the custodian is to accept the cash contributions provided by the employer on behalf of the investor. Additionally, the custodian is there to accept rollover investments from any other IRAs that the participant has invested in the past.
Let’s review three actions your custodian must take to properly report your SDIRA.
This is the primary form that custodians are required to file on behalf of IRA owners. Form 5498 includes any retirement arrangements considered an IRA under section 408(q) and lists all contributions made to the account during that year.
Reporting Your FMV
You must report your Fair Market Valuation (FMV) on your annual tax return by filing Form 5498. Typically, your custodian will handle filing this form for you.
Owner Actions and Responsibilities
For the most part, tax forms are handled by your custodian, but you may still be responsible for the following forms:
Form 1099-R: This form is required for anyone who has made a distribution of at least $10 from profit sharing, retirement plans, IRAs, annuities, or certain other options. Like other 1099 forms, the 1099-R classifies your IRA distributions as a form of profit that can be subject to tax, depending on the structure of your IRA.
Form 1065: If your IRA LLC is a partnership, you will be required to file Form 1065. You will need to use Schedule K-1 to determine each partner’s share of the business, and then that information is used to fill out Form 1065.
Single Member LLC vs. Multi-Member LLC
While owners of a single-member LLC have the power to set up a SIMPLE IRA on their own, each owner in a multi-member LLC must make contributions based on the written SIMPLE IRA agreement.
By default, single-member LLCs are taxed as a sole proprietorship, which means the business is not required to file taxes at a corporate level. Meanwhile, multi-member LLCs aren’t taxed directly. Instead, each partner reports his or her earnings individually based on their ownership stake in the company according to Schedule K-1.
While you may think your IRA exempts any and all business income from taxation, you would be mistaken. In special cases where income is generated from a tax-exempt entity (i.e., your IRA), but is considered separate from the tax-exempt purpose of your IRA, you can be taxed.
For example, let’s say you invest in a business that leases commercial space to a retail store, and you generate passive income from that retail shop; that will trigger the UBTI tax.
Likewise, short-term real estate flipping could also trigger UBTI if done in under 12 months.
Any exempt organization that has $1,000 or more in annual gross income from an unrelated business is required to file Form 990-T with their annual tax return.
Unrelated Debt-Financed Income (UDFI)
Unrelated Debt-Financed Income also referred to as UDFI, is generated when an IRA borrows money to invest in real estate. Any investor with UDFI must file IRS Form 990-T with their annual tax return.
While many of these forms are for special instances, it’s still important to understand each form you may be responsible for.
Form 5304 SIMPLE
Form 5304 SIMPLE is used when plan participants choose a financial institution that receives part of their SIMPLE IRA plan contributions.
Form 5305 SIMPLE
Form 5305 SIMPLE is used when you, as the business owner, choose the financial institution that receives all SIMPLE IRA plan contributions.
Form 1040 (Deductions for SIMPLE IRA Contributions)
Employees who contribute to their own retirement account must report their annual contributions on Form 1040, Schedule 1, Line 28.
Form 1065 is used to report the losses, deductions, credits, and contributions in a business partnership.
Form 1120 is used by C Corporations and LLCs who file as corporations.
Form 1120-A is a short form used for a US corporation.
Form 1120-S is the form domestic corporations use to report their gains, losses, deductions, credits, contributions, and more.
Luckily, you will not be responsible for filing many of these forms, and your custodian will alert you and help you prepare each form for filing.
Preparing for the New Year
One of the most important parts of preparing your SIMPLE IRA program for the new year is to know about the new contribution limits. For instance, in 2023, the contribution limit for investors under 50 years of age is $15,500, while investors who are 50 or older may contribute up to $19,000.
When you know the contribution limits, you can more effectively plan your investments for the year.
One of the smartest moves you can make is to maximize your contributions early in the year, allowing your money to earn interest all throughout the year.
Additionally, the beginning of a new year allows you to roll your funds over into an SDIRA or to find a custodian who is more familiar with the alternative investment options you’re considering.
Self-Directed IRA Tax Return FAQs
Am I required to file 990-T on My Tax Return?
If the total UTBI across all eligible investments totals $1,000 or more, you must file Form 990-T.
Do I Need to Calculate the FMV of My IRA?
The account holder is required to provide the fair market value for each asset owned by an IRA.
Does the IRS Audit Self-Directed IRAs?
Yes, the IRS audits self-directed IRAs.
What Do I Need to Do if My IRA LLC Includes Other Investors?
You are responsible for reporting any income that you have earned on your annual tax return, regardless of the presence of other investors.