To ensure that the FMV reporting is accurate, the actual value of the Alternative Asset held within your retirement plan has to be verified by an unaffiliated, independent 3rd party appraiser who has relevant expertise. Your personal tax professional, or attorney will often have contacts available to make such a recommendation. Often times your tax professional will be equipped to confirm the validity of this transaction at a very high level, due to their background and training.
Let’s look at a case study to better understand the mechanics of appraising an alternative asset held inside of a retirement plan, and what that means for fractional share holders of the asset during a conversion. There is a saying in the art world, that beauty lies in the eye of the beholder. Essentially, this states that an
item is only worth whatever someone is willing to pay for it, or in this case how much value a professional appraiser is willing to assign. This concept rings true in the matter of discounting alternative assets.
Let’s take a look at a closely held Limited Liability Corporation, that has been in existence for generations with many owners with varying proportional share values. In this scenario, Laura and Ted each own 20% of an LLC. The remaining 60% is owned by an Irrevocable Family Trust. The LLC owns Modular Homes, and transportation equipment with a book value of $2,500,000. Laura dies, and her shares would be passed along to Ted per the terms of the buy-sell agreement. They have hired an appraiser who specializes in modular homes to help them establish a fair market value for their respective ownership interests.
The appraiser determines that the FMV of the modular homes and equipment is $3,800,000. However, there are a few factors to take into consideration, most importantly, an established exchange for her shares does not exist, and Laura is not a majority owner. Additionally, their holdings represent a fractional ownership of the LLC. This inherent lack of marketability, makes it extremely difficult to assign the appropriate value for their shares, so the appraiser would likely apply a deep discount to the value of their holding for this very reason.
The appraiser subsequently applies a 40% discount to their shares which translates to a FMV of $304,000 as opposed to $760,000. This represents a $456,000 discount to the taxable income that the estate tax is based upon. In this instance the FMV calculation is justified, documented and supported.