By Beverly DeVeny
I get the same question every year at year end. “My client has an illiquid IRA and can’t take his RMD. Can we just write a note to IRS explaining the problem?” Every year my answer is the same. “NO.”
What is an RMD? It is a required minimum distribution.
What does required mean? From dictionary.com: “to call for or exact as obligatory; ordain: The law requires annual income-tax returns.” In other words, it is something you must do; you cannot get out of it.
So, how does an individual satisfy the RMD requirement when a retirement account holds an illiquid asset? If the individual has more than one IRA, the RMD from the account with the illiquid asset can be taken from an IRA that holds more liquid assets. When the individual has invested all of their retirement funds in this illiquid asset, then their only option is to take what is called an in-kind distribution. They must distribute to themselves a portion of the illiquid asset that equals or exceeds their RMD amount in value. The IRA custodian will issue a 1099-R showing the value of the asset that was distributed to the individual and the individual must include this amount in their taxable income on their tax return.
What’s the big deal if the individual does not take their full RMD? There is an excise tax of 50% of the amount not taken that is due in the year of the missed RMD. And, they still have to take the RMD even if they pay the 50% excise tax (remember the word “required”). If the 50% is not reported and paid, the statute of limitations does not start to run. That’s because the 50% excise tax is reported on Form 5329, which has its own signature line, and is therefore considered a separate return by the IRS. And, if Form 5329 is not filed, individuals can also be hit with failure to file penalties, and interest on both the 50% and the failure to file penalties.
This is something you do not want to fool around with. RMDs must be taken, even if the retirement account holds nothing but the illiquid asset.