Technical Tax Tuesdays – More About Roth Recharacterizations

Last month on Technical Tax Tuesdays, I wrote about Roth recharacterizations in general, and gave an example of a simple recharacterization. This month, I’ll look at a more complex recharacterization.

As mentioned in last month’s column, the tax consequences of a Roth recharacterization are simple if no other money has been put into the Roth IRA other than the money converted from a traditional IRA. Click here to find last month’s column.

The calculation of a Roth recharacterization can be more complicated if you’ve made other contributions into the Roth IRA beyond the traditional IRA conversion. Here is an example:

You have a traditional IRA with an account balance of $50,000 and a Roth IRA with an account balance of $10,000. You convert the traditional IRA into the Roth IRA, giving the Roth IRA a balance of $60,000. A few months later, the market drops and your Roth IRA drops to $54,000. You decide to recharacterize the traditional IRA conversion back into a traditional IRA.

To calculate the recharacterization amount, you have to allocate the loss between the converted traditional IRA money and the existing Roth money.

  • STEP 1: $50,000 was the amount of the original conversion.
  • STEP 2: $54,000 was the account balance on the date of recharacterization.
  • STEP 3: $60,000 was the account balance immediately after the conversion.
  • STEP 4: $6,000 is the amount of the loss from the date of the conversion ($60,000 – $54,000).
  • STEP 5: Take $-6,000 divided $60,000 = -.10.
  • STEP 6: Multiply -.10 x $50,000 = $-5,000.
  • STEP 7: Take the original conversion amount of $50,000 and add the amount from Step 6. In this case, that equals $45,000.
$45,000 is the amount to be transferred back into a traditional IRA. For tax purposes, it is as if the original conversion never happened. If this happens within the same calendar year, there is no tax consequence. If the recharacterization happens in the next tax year after the conversion, you will have to go back and amend the prior year’s return to cancel out the taxable conversion.