Tax Reporting Requirements for a Self-Directed Rollover IRA

by Fraser Sherman Google

    A self-directed individual retirement account can invest in almost anything you can imagine, with a few exceptions, such as buying collectibles. You tell the custodian what investments you want to make, and she carries out your directions. A self-directed IRA is tax-deferred like any other IRA. In most cases, you have no taxes to report on the earnings until you withdraw money.

    Rollover Rules

    If you roll over a traditional IRA into a self-directed traditional IRA, you don't pay any tax on the transfer as long as you complete it within 60 days. No tax is levied if the IRA custodian moves the money. If you transfer the assets over to a Roth IRA, you have to pay income tax on the money you move. You use Form 5498 to report such a transfer, unless your custodian handled it. You also use it to report any regular contributions you make to your account.

    Unrelated Business Income

    One exception to the IRA's tax-exempt status is if you buy a business through your IRA. Using your IRA to buy shares in, say, Starbucks isn't taxable, but buying a coffee shop and using IRA funds to hire a manager would be. IRA business ownership generates unrelated business taxable income, or UBTI; if it earns more than $1,000 in UBTI, it has to file Form 990-T and pay tax. This requires applying to the IRS to give your IRA a tax ID number. If your custodian isn't familiar with UBTI, he may not be able to help with the tax rules.

    Debt Financing

    You also face tax reporting if your IRA earns unrelated debt financed income, or UDFI. This rule kicks in if your IRA buys assets on credit, such as leveraged stocks or a rental property with a mortgage. It also applies if your IRA owns the assets indirectly, for example through a hedge fund or a limited liability company. If you earn more than $1,000 in UDFI during the tax year, the reporting requirements are the same as for UBTI.

    Withdrawing Money

    When you start withdrawing money from your IRA, you have more tax reporting to do. Your custodian will send you and the IRS a 1099-R reporting any withdrawals for the year greater than $10. The 1099-R also identifies how much, if any, of the withdrawal was taxable. You report withdrawals on your Form 1040, identifying the taxable and nontaxable parts. You keep the 1099-R for your own records; you don't have to send your copy to the IRS.

    About the Author

    A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.

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