The need for an independent appraisal report with a Fair Market Value form arises because the self-directed IRA holds a non-publicly traded asset and:
1. It is the end of the year, or
2. The IRA owner is converting their IRA to a ROTH IRA, or
3. The IRA owner has just inherited the IRA , or
4. The IRA owner has reached the age of minimum distribution requirements
Because the use of LLC interests in IRAs is becoming more popular, there are more and more people in the situation of needing a Fair Market Valuation report.
When you convert your IRA to a ROTH, you must pay the income tax associated with the conversion up front, as ordinary income. When your IRA holds a non-publicly traded security, Real Estate, or Interest in an LLC, or other private investments, your custodian needs to know how to report this to the IRS. Your custodian will have a form for you to fill out, as well as a requirement that you submit an independently prepared appraisal of each asset.
The concept of "fair market value" arises in other areas of taxation, including gift tax and estate tax. For all tax purposes, "fair market value" is based on a traditional "willing buyer – willing seller" standard. Specifically, the fair market value of an item of property is "the price at which the property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts."
The standard of "fair market value" is an objective test using hypothetical buyers and sellers; it is not a personalized one that envisions a particular buyer and seller.
The appraiser must be qualified in providing values to assets like the assets held in your IRA. The appraisal must be done by an independent appraiser that is not involved in the administration of your IRA. The appraisal can also not be done by anybody who has a vested interest in what the value is determined to be. This includes the IRA owner, a relative of the owner, a beneficiary of the IRA, an entity that does business with the IRA, or any person or entity whose compensation is contingent on a particular outcome of the IRA valuation.