Roth conversion and recharacterization

Submitted by [email protected] on Tue, 2009-08-25 04:21

If I do a Roth conversion of say $20K from a TIRA into an existing Roth account today, and invest the $20K in a stock that goes down 50% before year end, can I then sell that stock and re-characterize the $10K I get for it back into the original TIRA, and thereby wipe out the obligation of paying tax on the entire $20K that was originally converted…? If so, does any trading activity of other holdings within that Roth account affect this ability…? How does one document such activities for the IRS…?

Thanks…!



Submitted by Alan Spross on Tue, 2009-08-25 20:37

The earnings formula used for recharacterizations requires that the investment result of all the holding in the Roth account be considered, not just the holding you converted. As a result your math would only apply if the entire Roth account including all holdings also declined 50% during the conversion period.

If the other holdings had gains that matched the loss of your conversion stock, then 20k would go back in a recharacterization. If you had a total gain, then more than 20k would go back. The only way to limit the calculation to your converted holding is to convert into a new Roth account, and then there is no calculation needed because whatever the account balance is at the date of recharacterization is the amount that goes back to the TIRA.

While your trading activity is not limited in any way, the calculation method remains the same that dictates the amount that goes back. You have the option to decide WHICH current holdings in the Roth are used to actually complete the recharacterization.

So if you want better control of the conversion process or are converting using certain strategies such as keeping only the best performing conversions, you should make each conversion into a separate Roth account.



Submitted by mk foss on Wed, 2009-08-26 00:21

I agree with Alan. In your proposal you could convert some of your traditional IRA to a new Roth – once you reach the recharacterization deadline (October 15 of the next year) you could roll the new Roth into the prior Roth if you didn’t recharacterize. The regulations speak of recharacterizing dollars not securities – but you short cut all of the work by doing the conversion to a new account as Alan suggested.



Submitted by [email protected] on Wed, 2009-08-26 23:24

Thanks…!

Just to confirm, is there any restriction on the number of separate Roth accounts an individual may hold…? I would assume not. I would just let them remain separate accounts indefinitely, thereby keeping the total dollar value of each account lower. Since I’m looking to invest significantly in MLPs, I would attempt to keep the net UBTI below $1000 in each account to avoid the UBTI tax filing.



Submitted by Alan Spross on Wed, 2009-08-26 23:33

There is no limit to the number of Roth IRA accounts you maintain or for how long. For distribution tax purposes, they are essentially combined as if one large Roth. But for recharacterization calculations, the rules apply to the specific account that received the conversion. Recharacterizations can be done on part of a conversion or on certain conversions and not on other conversions.

There is no need or requirement to ever re combine the accounts, but most taxpayers would want to do so for record keeping simplification. As for the $1,000 limit for UBTI, it is generally considered that this limit applies over all IRA accounts, but the IRA custodians operate on a per account basis in flagging filing of the 990. In the event of IRS audit however, the IRS would levy the tax based on the total UBTI in all accounts. In other words, there is a gap in custodian monitoring vrs the actual tax requirement.



Submitted by [email protected] on Wed, 2009-08-26 23:58

>

WOW… what a can of worms this could open….!

Has there been a tax court ruling to this effect…? Anybody ever have it happen….?

Perhaps this board is not the proper venue for this question, but I’ll take a shot anyway: Presumeably, if doing an audit (based on the combined UBTIs), the IRS would make that decision just on the K-1s that they receive all related to a single SS number filing. In that event, do they then go to the individual with a tax $$ demand, or to the IRA fiduciaries and demand the 990’s be filed by all..?

(Of course in the case of an audit triggered by an unrelated event it gets even messier…)

Would be quite a bummer to have to pay all the fiduciaries for filing all those docs… and then the taxes too…



Submitted by mk foss on Thu, 2009-08-27 01:52

If a Roth or traditional IRA is invested in a partnership that has UBI – IRS receives a Schedule K-1 with the account owner’s address on it but the IRA custodian’s EIN for that account. If UBI is generated from a rental property held by the IRA, there is no income reporting to the IRS but there is reporting on mortgage interest.

A few years ago IRS tried a K-1 matching program and many individuals got letters asking why they didn’t report the IRA’s income on their 1040. Because of flaws in the program, IRS terminated that project but they could start up again at any point. I’ve prepared 990-T forms for IRAs in the past and IRS has always accepted the numbers but have been very fast in assessing underpayment penalties because the IRA does not have the same “safe harbors” as an individual.

It’s much easier to avoid investments that generate UBI.



Submitted by [email protected] on Fri, 2009-08-28 03:27

Thanks, Mary…!

Perhaps you can teach me a bit more… re these two statements:

>

I think the answer to that is there’s no place to report UBI into an IRA on a 1040. So how would an individual do it…? Would the IRS assess a penalty to the individual for not reporting it…?
—————-
>

I’m not sure I understand this one. Are you saying you submitted 990s showing tax due, but without payment of the tax…?

From my point of view, the more important question is Alan’s statement re summing all one individual’s IRAs into the single $1000 exemption. From my reading of the 990 instructions, each IRA stands alone. Also, an investor friend of mine claims to have got an explicit statment from his broker that’s the case. Has the IRS issued a statement instructing otherwise…?

In addition, that broker also claims that all the positive and negative UBIs are summed to get the total UBI for each IRA. At the time, from my reading of the instructions, I had thought the negatives could NOT be subtracted from the positives, but when I went back and looked, I could not find the reason for that opinion.

From discussions on an MLP forum I monitor, I understand common procedure is to sum the positives and negatives, and also carry forward net negatives within a particular company (up to 5 years I think).



Submitted by Alan Spross on Fri, 2009-08-28 03:57

It is very difficult to piece together specific documentation on this issue, because the IRS has not really clarified the situation. I cannot prove that their intent is to combine IRAs with anything but circumstantial reasoning, and the 990 instructions do not do any justice to this specific question. We do know that enforcement is done through individual IRA custodians, who do not all act uniformly in how they handle their responsibility. This leaves an obvious gap since each individual IRA custodian has no idea how many IRAs you have or how many may contain UBTI.

However, the two statements attributed to the broker in your post seem contradictory. If he maintains that each account is independent, why would the netting of UBTI income and losses even be an issue? I agree that if they are NOT independent then the netting does become the next question to be addressed.

Perhaps someone else has more specifics, as I wish we could at least reduce the many areas of question surrounding this question.



Submitted by mk foss on Fri, 2009-08-28 04:36

I want to clear up some confusion from my earlier post.

If the IRA has UBI, the IRA must file Form 990-T. Technically all IRAs of the owner can be combined for the 990-T filing. Custodians are responsible for the filing and for having the tax paid from the IRA – but they may not have access to all IRAs so they won’t take responsibilty for UBI from investments they don’t manage.

The IRS matching program that I mentioned was just an error by IRS. They were looking for IRA income on the owner’s 1040. The IRA income would never be reported there; the only taxable income reporting by an IRA would be on Form 990-T. They had to scratch the program because it was something they just couldn’t monitor using computers alone.



Submitted by [email protected] on Fri, 2009-08-28 18:14

>

Alan, you misunderstood my meaning re the combining of positive and negative UBIs. I meant within a single IRA account. For example, in an account holding several MLPs, each MLP ticker would report a single UBI number, either positive or negative. Some investors believed that the total IRA UBI in that account would be the algebric sum of those, while others believed the negatives should be disregarded and all the positives totalled. Obviously this gives a higher UBI for the account. If algebraic summation is used, obviously the investor would seek to hold some MLPs with negative UBI to cancel out some of the positives and so remain below the $1K exemption. On the forum I monitor, some investors have done significant research to estimate future UBIs from past experience for each MLP they track, and so some success in this quest is attainable.

From your and Mary’s updated comments, I would reasonably conclude that the IRS is currently applying the law as it applies to individual 990 filngs on the indvidual IRA accounts, and not persuing the idea of totalling these for an indivdual investor. IMO, this would be the right thing to do, as the UBI tax itself originated long before IRAs and seems to have been targeted to eliminate the possibility of abuse whereby untaxed organizations such as trusts might be used to own operating businesses, thereby giving them an unfair competitive advantage…

Thanks much to both you and Mary for and informative discussion….!



Submitted by Lakshmi Goriparthi on Tue, 2015-03-17 21:43

I hve a existing Roth IRA.  I converted some of my 403 b Money to IRA and convered to Roth IRA into the same existing account.  I have losses.  I have some stocks.  How can i calculate the amount that I converted to roth. back to IRA.  I do not want to pay taxes on losses. Can I recharacterize the stock instead of liquidate.can some one help methanksLakshmi.



Submitted by Alan - IRA critic on Tue, 2015-03-17 21:52

You can still recharacterize a 2014 or 2015 conversion. The custodian will calculate the gain or loss on the conversion and transfer the conversion plus or minus gain or loss back to your TIRA account. That will eliminate the taxes on the conversion and there will be no current tax due. The assets you choose to transfer back to the TIRA must equal the dollar value of the calculation, so you can transfer the stocks that remain and if that is not enough, you can use the other assets in the Roth to make up the difference.Here is a calculator to use to determine the dollar value to be transferred to the TIRA, so you will know the correct amount before you request it. Of course, with stocks the dollar value will change daily:http://www.money-zine.com/calculators/retirement-calculators/ira-recharacterization-calculator/



Submitted by Lakshmi Goriparthi on Tue, 2015-03-17 22:06

I have the semilar question.  I have cobined my Conversion with existing roth account whole account has losses.  But how can I calculate the amount to recharacterize.  is it a percentage or any other way. Thanks,Lakshmi.



Submitted by Alan - IRA critic on Tue, 2015-03-17 22:16

The custodian will do the calculation math. All you have to do is request recharacterization in terms of the dollar amount of the conversion. So if you are doing a total recharacterization request of recharacterization of your entire conversion. But if you want to do a partial recharacterization, for example 10,000 of your conversion then request that 10,000 of your $x conversion be recharacterized. The custodian will calculate the amount of earnings to transfer. But they might have a form for you to indicate which assets you want transferred first. For example, you might want certain stock or mutual fund shares to be applied first, then a bond fund and a mm fund last. The custodian will transfer in that order and stop once the value of your indicated holding reaches the dollar amount including earnings that must be transferred. If you have losses, you should estimate the amount of loss yourself to make sure that the custodian does not transfer too much back to the TIRA. If you have a loss on a conversion, they transfer less than your converted amount back to the TIRA. On the other hand, if you had a large gain, you would want to know how much since you then might want to keep the conversion and the tax free gains already generated. With gains your effective tax rate for the conversion is less because you are not paying taxes on the gains.



Submitted by Lakshmi Goriparthi on Tue, 2015-03-17 22:17

Hi Alan,Thanks.  But my question is.  I have existing Roth IRA and I rolled over some IRA money to The same existing Roth.  Whole account has losses.  I want to recharactarize the money I rolled over from IRA.  Total account value has shrink.  How do clculate my losses and transfer the portion of account back to IRA.  I do not want to pay taxes on losses.Thanks,Lakshmi.



Submitted by Alan - IRA critic on Tue, 2015-03-17 22:31

When you convert into an existing account, the gain or loss must be calculated on the entire account, not just on the amount of the conversion. So if the whole account has a loss, then your conversion is also considered to have the same % loss and that % loss reduces the amount transferred back to the TIRA. No taxes will be due if you request a total recharacterization of a specific conversion. Custodians have software that automatically calculates the earnings or loss, but if you want to check their calculations to make sure they are correct, you can use a tool like this:   http://www.money-zine.com/calculators/retirement-calculators/ira-recharacterization-calculator/



Submitted by Lakshmi Goriparthi on Wed, 2015-03-18 00:19

anybody no know the answer to my missed up roth. I made so complocated to myself



Submitted by Lakshmi Goriparthi on Wed, 2015-03-18 00:22

Thanks Alan



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