Fair market valuation for IRA LLC containing notes
I read that the Fair Market Value for the IRA LLC is basically a combination of theFfair Market Value of the assets. Notes I read are valued based on the UPB and unpaid interest.
I wanted to check if that’s how most people do value. When they say unpaid interest, I assume they mean for the remainder of the term left.
Valuation for a note is the open balance plus the accrued and unpaid interest. So if payments are made on the first of the month and valuation is being done on the 31st, that 31 days of interest since the last payment is what would be added to the value.
@Brian Eastman thanks and accrued and unpaid. So those 31 days of interest added to the future interest earned until the end of the term.
No. Just the 31 days, not the future interest.
That makes sense. Unless they are non-performing and have a larger than 31 days worth of interest still. Right?
@Brian Eastman how about if there are no monthly payments and it just has one balloon payment at the end of the term? Would you consider the accrued interest to date? Even though none has been paid. Thanks
That is exactly correct. The note contract will determine how interest accrues, and payment may occur on a different schedule. The accrued but unpaid interest is part of the "current value" of the note as an asset.
#5 All Forums Contributor
- Lender
- The Woodlands, TX
@Peter Halliday
Notes valued at unpaid balance plus accrued interest may be how pension plan service advisors prefer pensions be valued, but that leads to sometimes extreme over valuations and occasionally undervaluations. For example, my fund has a commercial mortgage note we purchased recently for $1.775 million, with an UPB of $3.3 million. His payments are figured at an interest rate of 9.5%. I would argue, that based on the price the bank was willing to sell the note, the borrowers extremely poor payment history, and the collateral value being closer to $2.5 million than $3.5 million, the note is worth , at market value perhaps no more than $2 million, or maybe just the $1.775 million we paid. If we were to value the note at $3.3, we would have the following situation
1. A valuation based on unpaid balance while the MARKET PRICE ACTUALLY PAID, IN A NON DISTRESS TRANSACTiON, which is the BEST indicator of market value, was 46% LESS!
2. We would by definition have an unrealized immediate 86% GAIN or profit, while in actuality we could not sell the note for much more than 60% of that amount.
3. A situation where market value is determined by only one of many factors affecting valuation. For example is a 30 year fully amortized $1,000,000 UPB note with a 3% interest rate worth exactly, or anywhere near the same as a 5 year note of $1,000,000 unpaid balance with a 12% interest rate? Is a note in default with collateral that won't be able to be sold for anywhere near the UPB worth the same as a fully secured performing note of the same UPB.
In reality, utilizing one single determinate of value and ignoring all others is taking the “the easy way out”. It’s easier, it’s just not correct.
@Don Konipol thanks so much for some very insightful and thoughtful answers. The purpose of a valuation certainly should drive the process. I am pretty ignorant of what the IRS does with these valuations the IRA Custodian send in besides track people who they should keep tabs on. I also agree the ultimate strategy should impact your process. If you plan to hold than maybe UPB + accrued interest is fine. But if you plan to sell that should influence your process.
As a side not I like be that the IRS acknowledges they have not to set guidance to n how they want things valued.
The end of year fair market value is just a marker in time. For most investors, there is no taxable impact, and if the value changes from one year to the next, that is what happens to retirement plans.
Valuing the IRA owned LLC in a self-directed IRA is the equivalent of a conventional custodian looking up the publicly reported value of a stock or fund. It is just an estimate as of that point in time. Because the LLC is not public reported, the IRA custodian comes to you for an end-of-year value to use on their standard reporting.
The exception is someone who is planning to execute a Roth conversion or who has an account that is subject to Required Minimum Distributions. In those cases the value is driving some kind of taxable event, so the more complex methodology outlined by @Don Konipol on a non-performing note may be applicable.
You would want to engage a licensed tax professional and/or appraiser if you intend to report anything other than open balance and accrued but unpaid interest on an account with any kind of associated taxable event.
#5 All Forums Contributor
- Lender
- The Woodlands, TX
"Valuing the IRA owned LLC in a self-directed IRA is the equivalent of a conventional custodian looking up the publicly reported value of a stock or fund. It is just an estimate as of that point in time."
Not true at all. The publicly reported value IS the market price, the most recent transaction price, or the current bid and asked. In many case, in almost any publicly traded issues the quoted price will be at or within a fraction of a percent of the market price.
Actually, valuing the IRA notes using unpaid balance is the equivalent of a conventional custodian using the par value the stock was originally issued at as reference for the value. BTW, in the case of a self directed or solo 401k with a value over $250,000, form 5500 or an associated form such as 5500EZ must be filed annually with the IRS. The form information required includes last years value of the retirement account, any contributions, any realized or unrealized gains, and the value for the subject year. Valuing the retirement account notes by UPB and reporting such to the IRS will leave A LOT of explaining to do if and when the participant converts to Roth status and THEN values the account, for Roth conversion purposes, at REAL market value. I would suppose doing such would amount to sending a letter to the IRS with your tax return "requesting an audit" LOL. Conversion to a Roth can make sense for any number of reasons unforeseen presently, such as tax changes, family issues, etc. I personally am very glad I always valued my Solo 401K notes and note fund investments at real market value and not at UPB. Made the historical 5500 filings with the IRS totally consistent as per valuation with the conversion valuation.
#1 All Forums Contributor
- Investor
- Virginia
For non performing notes we typically look at the balance sheet and take the asset side of the loan. So if we paid $20k for it and had $7k in costs and zero receipts we would value it as $27k. If it’s ever questioned we can provide the balance sheet for the custodians records.
@Chris Seveney I assume once you take possession of the property and have real property, then the valuation would change. More along the lines of a traditional valuation for real estate: Appraisal or BPO. I think this sounds like a bit more of a realistic than UPB, which for a non-performer could be enthusiastically high. Nothing is perfect, because in the unlikely case of a getting the buyer on track, you'd have a jump in valuation, but I would argue it would be warranted.
I'm curious what your option is on the valuation of performers. Do you personally use the UPB + unpaid interest, an estimate of market sale price, or something else entirely.
#1 All Forums Contributor
- Investor
- Virginia
Real property is treated as such. For performing we use what Brian Eastman noted above.