Tuesday, October 5, 2010

Roth Recharacterizations: What Happens To Earnings or Losses

It’s time to do those last recharacterizations for 2009 and file those last returns. October 15, 2010 is the deadline for both.

When you do a Roth recharacterization, your recharacterization request is for the amount of the original conversion that you want to undo. Then you do a net income calculation and come up with the actual amount that will be transferred back to the traditional IRA. (More details on this can be found in IRS Publication 590.) The amount transferred back can be more than the original converted amount if there were gains in the Roth account or it can be less if there were losses in the Roth account.

Many taxpayers and their advisors then ask what happens to that gain or loss. The simple answer is “Nothing.” A Roth recharacterization is an undo. For tax purposes, the converted funds are treated as though they never left the IRA. So any gains or losses are treated as though they were earned inside the IRA. There is no loss you can deduct on your tax return and there is no gain to be taxed on the return.

But don’t forget to let IRS know that you have recharacterized your Roth conversion. A note must be attached to the tax return or to the amended return that gives IRS the date and amount of the conversion and the date and amount of the recharacterization. This should prevent any future communications from IRS asking for any taxes, interest, and/or penalties on the transactions.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC