LOSS ON CONVERSION FROM TIRA TO ROTH
I’ve got a client with the following situation:
They converted ALL $25,000 of traditional IRAs with a basis of $32,000 to a ROTH IRA in February 2010. They have no remaining TIRAs after the conversion. The $7,000 loss will be erased by the 2% floor when they itemize their 2010 tax return. Their employer sponsored 401k plan allows for in-service withdrawals of pre-tax employer contributions (Match).
Q: Can they rollover $7000.00 from their employer sponsored 401k match in 2010 to a TIRA, and subsquently convert to a ROTH resulting in a tax free net against the previous exisitng $7000 loss from conversion? (rather than lose the loss due to 2% misc itemized deduction limits).
Permalink Submitted by Anonymous (not verified) on Fri, 2010-03-26 17:44
I am not aware that you can take a loss on a Traditional IRA while doing a conversion. Only if you distribute all Traditonal IRAs. While a conversion is technically a distribution it is followed by a subsequent rollover contribution. Where is this stated?
Thanks.
pko
Permalink Submitted by Alan Spross on Fri, 2010-03-26 19:36
pko,
If someone closes out all their TIRA accounts in either a distribution or conversion, the amount of remaining basis creates a potential misc itemized deduction subject to the 2% floor per p 40 of Pub 590. You are correct that the IRS has not specifically ruled on conversion closures, but until they do most pundits recommend taking the deductible because the taxpayer has technically qualified with the requirements. In addition, the IRS requires the types of IRAs to be separated, ie closure of all a single type of IRA is required for the deduction. The only other equitable solution I have seen discussed is transferring the remaining basis to the Roth IRA. Interestingly, this is what officially happens when a designated Roth (Roth 401k) which is underwater is transferred to a Roth IRA. The loss from the Roth 401k is allowed to increase the Roth IRA basis in regular contributions. The IRS has had since 1998 to address this issue, but have not done so.
But the poster’s recommended solution will work and avoids the previous issue entirely. As long as the plan allows this specific in service direct rollover to a TIRA, an immediate conversion of that amount to a Roth IRA will absorb the remaining basis. Taxpayer will end up with a 1099R showing a total conversion amount of 32k and the 8606 will apply the 32k basis such that 32k will be a taxfree conversion.
The QRP rollover and conversion should be done this year to avoid opening up another unanswered question. That question would be whether the 7k of leftover basis carries over to future years with no TIRA balance if taxpayer does not or cannot use the misc deduction – or whether the basis is forfeited. But this question can also be avoided by adding the 7k of pre tax dollars to the TIRA as a rollover this year.
Permalink Submitted by Joe Blow on Tue, 2010-03-30 20:18
Thanks for your reply. I will be careful to make sure to recommend that all transactions are compelted this year to avoid the problem with basis carryover into the next year.