Taking a Self-Directed IRA distribution of an in-kind asset has a similar tax characterization as a Roth conversion, but they are quite different in terms of their impact on the value of the IRA owner’s retirement account.
- One can distribute or convert any IRA asset
- You may choose to distribution cash, or an in-kind asset from your IRA
- It’s important to be aware of any tax consequences when moving an asset from your IRA
Tax-Free Self-Directed IRA Rollovers and Transfers
Before I get into describing how one can take an-kind distribution of a self-directed IRA asset, I think it is helpful to briefly describe the tax-free ways one can transfer or rollover retirement funds into a Self-Directed IRA.
Transfer to a Self-Directed IRA
A transfer is when you move assets from one IRA to another IRA. One may choose to transfer IRA funds or assets from one plan to another at any time. The transfer of cash or in-kind assets is not subject to tax and can be done an unlimited amount of times between IRAs.
Direct Rollover to a Self-Directed IRA
A direct rollover occurs when non-IRA retirement funds are moved to an IRA. A direct rollover is typically done via the movement or cash or retirement account assets from a 401(k) or similar retirement plan to an IRA. A direct rollover to an IRA is tax-free and can be undertaken an unlimited number of times. Like an IRA transfer, a direct rollover can consist of cash or an in-kind asset, such as real estate, stocks, and cryptos.
Indirect Rollover to a Self-Directed IRA
An indirect rollover arises when the plan assets are rolled over to the retirement account holder first, before the funds are ultimately rolled into a Self-Directed IRA. Once the rollover occurs, the account holder has sixty (60) days to roll the retirement funds into a new plan.
Essentially, you can choose to use those funds for any purpose, so long as they are contributed in full to a retirement plan in that time frame. Any funds not rolled over into a new plan will be deemed taxable distribution. Taxes will be owed on the amount not rolled over, and a 10% early distribution penalty may apply.
An indirect rollover can only be done once every twelve months for all your IRAs. For example, if an indirect rollover is done June of 2023, you may not perform another one until June of 2024.
Taxable Self-Directed IRA Distributions
A Self-Directed IRA owner can take a distribution from his or her IRA at any time. When an IRA holder takes money out of the plan by way of a distribution, the amount distributed no longer benefits from the power of tax-deferral and ultimately, the future value of the remaining IRA will be impacted.
Traditional IRA Distribution
In in the case of a traditional, or pretax IRA, the IRA holder can take a distribution of the assets at any time. However, a 10% tax generally applies if one withdraws IRA assets before he or she reaches the age 59 1/2. Since a traditional IRA contribution is made with pretax funds, all distributions will be taxed at your ordinary income rate for the year.
Traditional IRA In-Kind Distribution
A Self-Directed IRA owner can also take an in-kind distribution. An in-kind distribution simply means that the IRA owner is taking a taxable distribution of the IRA-owned asset versus cash. The same tax rules that apply to cash distributions apply to in-kind distributions.
For example, if your Self-Directed IRA owns a house valued at $250,000 that the IRA owner wants to use, he or she can simply take an in-kind distribution of the house and pay tax on the fair market value of the home. Again, if you are under the age of 59 1/2, you will owe taxes as well. Title of the home will be changed from the IRA to the individual IRA owner personally.
Self-Directed Roth IRA Distributions and Conversions
As opposed to a traditional IRA, Roth IRAs are funded with after-tax funds. There is no upfront tax breaks, however, all qualified distributions will be tax free. This includes both contributions to the Roth, and any gains or income generated by the plan. It’s a powerful tool used by retirement savers to avoid taxes during retirement.
Roth IRA Distribution
If a Roth IRA holder takes a distribution prior to the age of 59 1/2 and/or any Roth IRA has not been opened for at least five years prior, the earnings on the Roth IRA contributions would be subject to ordinary income tax, as well as a 10% early distribution penalty. Keep in mind, Roth IRA contributions can always be distributed without tax.
In other words, if a Roth IRA holder wants to be able to guarantee that the earnings on the Roth IRA contributions will also be available for distribution without tax or penalty (a qualified distribution), the Roth IRA holder must be at least 59 1/2 and must have opened and funded a Roth IRA at least five years prior to the distribution.
Roth IRA In-Kind Distributions
As with the Traditional IRA, a Roth IRA owner can take an in-kind distribution of an asset owned by a Self-Directed Roth IRA. The taxation of the in-kind distribution will follow the same tax principles of a Roth IRA cash distribution. All qualified distribution of the in-kind asset will be tax free.
Roth IRA Conversions
A Roth IRA conversion occurs when one wants to move traditional IRA assets to a Roth IRA. Unlike a distribution, where the IRA owner takes personal ownership of an IRA asset, the assets involving a conversion will remain in the IRA world. You are simply moving them from a pretax account to a Roth.
In general, one is eligible to make a Roth IRA conversion at any point during the year. You can choose to convert either cash or in-kind assets. The amount converted will be subject to tax based on the fair market value of the assets. In the case of cash or publicly traded securities, determining fair market value is quite easy. However, in the case of real estate or other alternative assets, one would be required to determine the fair market value of the IRA asset being converted.
Tax planning should be considered in conjunction with a Roth conversion. Electing to do a Roth IRA conversion of a depreciated asset, such as stock or cryptocurrency, would allow an IRA owner to pay tax on a depressed value and gain the ability to lock in tax-free gains on the asset (keeping in mind the qualified distribution rules).
The tax on the Roth IRA conversion would be due by April 15 in the year following the conversion. The amount of the pretax IRA conversion is treated as income and added to the income of IRA owner on his or her Form 1040.
Conclusion
Understanding the in-kind distribution rules are important to identify an efficient way for a Self-Directed IRA owner to get access to an IRA asset. Likewise, Roth IRA conversions provide an opportunity for one to turn a taxable asset into a tax-free asset.
With all things being equal, it’s always best to keep assets in the retirement world because of the enormous tax benefits. Before performing a rollover, transfer or conversion, make sure you are aware of any tax consequences or penalties. It’s best to work with a financial advisor before making such decisions. If you have any questions, feel free to leave a message below.
