How a Re-Characterization is Treated
Wondering how to explain to client what to do on their tax filing, when it comes to ‘Re-Characterizations’ ??
Example – Client did a conversion from his IRA account to his Roth IRA last year (say in March 10′) and the valuation of that conversion was $390,000.00 and a 1099-R was generated (from the ‘traditional IRA’ for that amount. The client lost a considerable amount of money in the market over the next few months and decided to ‘Re-Characterize’ the conversion, thus going back to the IRA account … In doing that, the calucation was done for the re-characterization and the amount that was re-charactized was $96,500.00 and a 1099-R was generated (from the Roth IRA) for that amount as well ….
The question is, when the client is doing their 2010 tax filing, how do they report the ‘Re-characteriztion’ properly … Being that the original amount, converted and the re-characterized amount are so different in value … The idea behind the re-characterization was to avoid the tax obligation created with the orignal coversion of $390,000.00 … I see on the 2010 1040 tax form, where it has a spot for the original conversion value. However, I don’t see where they would indicate the re-characterization to off-set the conversion.
Any input would be greatly appreciated…
Thank you –
Permalink Submitted by Alan Spross on Tue, 2011-02-08 18:50
Since he received a 1099R for the recharterization, this was apparenlty completed in 2010.
Since he now has no conversion, he does not attach Form 8606 to his return, but will need to attach a complete explanatory statement explaining what transpired.
For example, “On 3/11/2010 I converted 390,000 to my Roth IRA, and due to severe losses in value, I recharacterized 100% of my conversion, which was then worth 96,500 back to my TIRA on xx/xx/2010.”
Note that for a loss of this magnitude, the IRS might suspect that he did a partial recharacterization since such as small amount was left to recharacterize. He may eventually need to provide the IRS will evidence that this was a 100% recharacterization if they ask. IRS information only asks for the value of what goes back to the TIRA, but no where on the 1099R is a place to show how much of the original conversion was recharacterized, so he should be forewarned of a possible inquiry.
As for his 1040, line 15a should include the total of the conversion and the recharacterization (486,500), and 0 goes on 15b.
While this loss in his Roth might have occurred in the investments he converted, it also might occur with other assets in the Roth and generate this 75% loss. But be sure he recharacterized the entire conversion and not just part of it.
Permalink Submitted by Gregg Guiol on Tue, 2011-02-08 19:52
Alan –
As always…THANK YOU !!!
Your prompt and concise answers to all my questions over the years is greatly appreciated …
Gregg Guiol