In-Kind IRA Distribution

[bevantaxservices]

My tax client received an “in-kind” distribution from an IRA in 2020.  Taxable income was $110,000 and the distribution was coded in Box 7, as K7.  K=No readily available FMV 7=Normal Distribution.  The IRA had been established 40+ years ago and a large cash balance had been accumulated over the husbands working career.  The IRA was converted to a self-directed IRA and 3 building lots in a high end golf course development, were purchased for $300,000.   Eventually the husband passed and the wife(my client) inherited the IRA.  I had no prior knowledge of the IRA and neither did the wife.  Over 50 years, the lots had depreciated from the original $300,000 to a FMV of $110,000 in 2020.  The lots were appraised and the title company transferred ownership to the client.  I had been sweating having to tell the client she was going to have a large tax bill but she had already been briefed by the Trustee.

So check out my questions and assumptions.  I would be grateful for any comments or suggestions on this matter.  Thank you.

1.  The basis of the lots will be $110,000 for future tax purposes.

2.  The $190,000 is lost forever and there is no deduction for the loss.

3.  The lots will have a FMV step-up to the heirs when my client passes, even if she moves the lots in to a Grantor Trust.

4.  My client will have to pay taxes on $110,000 at ordinary income rates.

5.  There would have been no way to roll this over or combine it with another IRA because of the in-kind distribution.

Bill Bevan, EA

[sjrcpa]

1-4 I agree.

I don't know about 5.

[BobKamman]

How were the property taxes being paid all those years?

Did the decedent have zero basis in the IRA, or is there no way of knowing now?

[BobKamman]

5.  There would have been no way to roll this over or combine it with another IRA because of the in-kind distribution.

But why was there a requirement for the in-kind distribution?  It's now a spousal rollover account, right?  Why did she have to take all three lots?  Why not just one?  Why not a 10% interest in all three?  Whenever someone with a self-directed IRA dies, is the beneficiary required to liquidate it?  For all I know, that's the rule.  Just haven't run across it yet.  

[bevantaxservices]

Good questions by Bob K.

1.  Property taxes were paid out-of-pocket by the taxpayer because she had no knowledge of the technical issues.  They should have been paid with funds in the IRA so I may have to do something to "repair" this oversight.

2.  The distribution from the IRA was initiated by the taxpayer for estate planning purposes.  She wanted to completely liquidate the IRA.  Also, the basis in the IRA was $0.

3.  A surviving spouse is not required to liquidate an IRA inherited from a deceased spouse.  Any other beneficiary is required to liquidate an inherited IRA and there are several choices available.

4.  An IRA can only be funded with pre-tax cash from wages, a direct contribution, or, with a rollover from another tax deferred account.  You cannot purchase an asset and contribute it to an IRA.  You can however, purchase  assets with the cash in the IRA.  You cannot roll over non-cash assets from an IRA. This is where the principal of the in-kind distribution kicks in.  An asset can be converted(or recharacterized) back to pre-tax cash and then become a distribution.  It is tricky and the IRS documentation on this subject is thin.  I can't quote you any IRS directives or rules on this subject but here's an article I ran across that discusses it in more detail.  Using Your IRA to Buy Real Estate (investopedia.com)

[BobKamman]

@bevantaxservices  "You cannot roll over non-cash assets from an IRA."

Where are you finding that?  It's certainly not in the Investopedia aritcle. 

I have a lot of clients with inherited IRA's who are in trouble if they couldn't rollover "in kind."  But then, Fidelity and Vanguard are in a lot of trouble too. 

My question about payment of property taxes wasn't about recent history.  Who was paying them for the 40 years the husband was directing it?  Were they being paid out of the IRA?  If he was paying them from non-IRA funds, there may be penalties involved, but they may add to basis. 

[bevantaxservices]

I appreciate your feedback on this IRA issue.

1.  Regarding the rollover of in-kind assets held in an IRA.  This probably goes in the category of "you learn something new every day".  The IRS is of little help on this subject.  I haven't done an exhaustive search of IRS opinions on this issue but I could not find any mention of directly rolling over IRA assets like, stocks, bonds, real estate, precious metals, etc.  What I mean by a "direct rollover" is that the assets do not have to be converted in to cash.  The assets can be directly transferred to another IRA.  I did find several articles on the subject for your reading pleasure.  They seem to indicate it is a function of the IRA custodian/trustee as to how this is implemented.

https://pocketsense.com/can-inkind-transfer-ira-4716.html

https://www.sapling.com/12230469/inkind-rollover#:~:text=An%20%22in-kind%20rollover%22%20is%20a%20me....

2.  On the other issue regarding who paid the taxes and where the money came from.  I don't have good historical documentation but I believe the IRA trustee paid the property out of cash funds in the IRA.  At some point......maybe 10 years back.....the wife started paying the property taxes out-of-pocket.  I know this is not correct but the IRA has been liquidated so not sure there is anything I can or need to do regarding this issue.

Anyway, thank you for comments and if you run across any official IRS documentation on this subject, let me know.  And vice versa.

[qbteachmt]

5. seems moot. You describe she wanted to liquidate, she did liquidate, and it was 2020, but this is April 2021. So, all of that is moot, now. No need to work on rollover considerations.

"I had been sweating having to tell the client she was going to have a large tax bill but she had already been briefed by the Trustee."

If it hadn't lost value, she would be paying taxes on $300k, so she's a bit lucky. Although, I'd be willing to pay taxes on something 3x as valuable, of course.

[bevantaxservices]

Thanks Bob, for the input.  What I was looking for here was to see if there was some "loophole" with the in-kind distribution that might reduce or eliminate the tax obligation on the $110K distribution.  There aren't any.  You are right that the rollover option is long gone.  But, what I did learn from our discussion was that a direct rollover of in-kind assets is possible, without converting them to cash.

[qbteachmt]

Distribution is distribution is distribution. If you tell the trustee, "I'd like that in Chickens," it's still that distributed Value. The nature of the distribution doesn't change that fact.

For this: "was that a direct rollover of in-kind assets is possible, without converting them to cash."

Maybe. It depends on the situation.

This is why you would have a Self-Directed IRA. The only thing I've ever had to convert to cash, when rolling SEP, SIMPLE IRA, and other IRA accounts into Self-Directed Traditional IRA, was some institutional mutual fund shares that were not to be held outside of their own "advisors." That holding gets Sold and the funds are then rolled over.

"An asset can be converted(or recharacterized) back to pre-tax cash and then become a distribution."

It can be Sold and the proceeds become part of the IRA available for distribution or to buy something else. It's not recharacterized or converted. What happens first will be within the IRA; it's just an Account. Conversion and recharacterization are no different than any other IRA. The investment type is different. You hold cash, mutual funds, shares of stock, real estate, gold, whatever qualifies. Not being liquid doesn't mean you can't move them to another trustee.