recharacterization and reconversion
We converted an IRA of $400k in dec.2010 into two accounts. One account is down 6%. If we recharacterize this account before 10/17, is it best to reconvert as soon as possible, or wait until january 2012 so we have until 10/13 to assess? Assuming that tax rates are the same in 2011 and 20012, is this basically a stock market timing issue? Thanks.
Permalink Submitted by Alan Spross on Thu, 2011-09-29 01:18
You need to wait only 30 days after recharacterization to reconvert a prior year conversion. The advantage of having an extra year to assess the conversion is nice, but would normally be trumped by your tax situation with respect to which year you want the conversion income to be reported. A 2012 reconversion will be taxed in 2012.
You also have another conversion in 2010 that you do not plan to recharacterize. Are you reporting that conversion in 2010 or half in 2011 and 2012? If you recharacterize one conversion, you may still have half the other conversion taxable in 2011 and 2012, so which year would you want the reconversion taxable. You might find it to your advantage to split the reconversion and do 1/2 in 2011 and the other half as a 2012 conversion. That will keep all these conversions taxable @ half each year.
Market timing may be another factor to consider, but like the extra year to assess this is also a highly contingent factor based on where the markets go after reconversion. Conversely, the year in which you report taxable income has much more predictable results with respect to your tax bill.
Permalink Submitted by Bruce Steiner on Sun, 2011-10-02 15:31
I’m quoted in today’s Wall Street Journal on recharacterizations and reconversions: http://online.wsj.com/article/SB1000142405297020413820457660554277020625….
If you expect to always be in a high income tax bracket, and you converted your IRA last year, and it’s gone down in value, you might want to consider recharacterizing and converting again. In general, you have until October 17th to recharacterize. If you recharacterize, you have to wait 31 days (or until the year following the initial conversion, if later) before reconverting — like a wash sale rule. Since the 35% top income tax rate has been extended through 2012, this may be useful to some people.
Permalink Submitted by Talia Pierluissi on Sun, 2011-10-02 22:26
Thanks! Does the market timing aspect of this worry you? There’s always the risk that the market recovers before you are able to reconvert.
Permalink Submitted by Bruce Steiner on Sun, 2011-10-02 22:52
The possibility that the market goes up during the 30-day period is a factor to consider. Its weight would depend upon whether the Roth IRA declined by a great deal, or only by a small amount, between the time of conversion and the time of the possible recharacterization.
Permalink Submitted by James Mitchell on Fri, 2011-10-14 18:20
I have a similar question with a twist. First, I have my TIRA segregated into a number of independent accounts at Vanguard. Each year, I convert several of these into separate Roths at Vanguard. Near the end of the year, I determine which have appreciated the most and how much I actually want to convert in that year based on tax considerations, and i recharacterize as needed to meet my target (back into the funds from whence they came).
This year, one of the funds as lost value and I’ve already recharacterized it. I would like to replace that conversion with a similar one using A DIFFERENT TIRA ACCOUNT (AND THEREFORE DIFFERENT FUNDS). Since the funds are different, I believe I can convert back into the same mutual fund that I just recharacterized out of without waiting until the next calendar year (going into a new Roth account, of course).
Does anyone see a problem with this? Thanks
Permalink Submitted by Alan Spross on Fri, 2011-10-14 20:47
There shouldn’t be a problem.
The disallowed reconversion rules apply to the same assets (ie tracing those dollars) but the actual investment used (funds) is immaterial. The specific IRA account #s however would be used to show the IRS that a conversion was allowed, if the IRS ever asked.
You are referring to a 2011 conversion that was recharacterized earlier back to the original TIRA account. If you now convert more funds from a different TIRA account, there is no problem since you are converting different assets than the ones you recharacterized. The recharacterized assets are in a different IRA than the one you are converting from. Again,the actual investment funds involved do not matter.
Your overall strategy is very useful for long term tax savings on your conversions, although it does create some reporting hassle and possible IRS inquiries you should try to minimize.
A couple tips in setting this up in a way that you can easily show the IRS what you did was allowed:
1) Direct your recharacterizations into a different TIRA account number than accounts from which you converted or intend to convert within the reconversion waiting period
2) If you can, do your additional conversions BEFORE you do the recharacterizations. You can then show the IRS dated statements that all conversions were done before any of the recharacterizations and therefore there is no way you could have reconverted recharacterized assets.
Fortuneately, the IRS rarely delves into disallowed reconversions. It would probably only happen if they were auditing you for some unrelated reason, and decided to look at your conversions in the process.
Permalink Submitted by James Mitchell on Fri, 2011-10-14 20:58
Thank you so much for the thorough answer. To be honest, I did not consider a “late term” conversion in the same year as I had already converted until after I had already recharacterized one of the earlier conversions. Your point about doing the additional conversion prior to any recharacterizations is a good one. I’ll do that next time. 😀
Thanks again!