Limits on recharacterizations of transfers/rollovers

Submitted by abura98 on Tue, 2015-03-10 21:15

In the IRS publication 590, it states that:

“Effect of previous tax-free transfers. If an amount has been moved from one IRA to another in a tax-free transfer, such as a rollover, you generally cannot recharacterize the amount that was transferred.”

http://www.irs.gov/publications/p590a/ch01.html#en_US_2014_publink1000230671

Could anyone speak more about the limitations here? In what cases is a custodian disallowed from recharacterizing funds originating from a transfer of assets? I assume if a customer has only made a 2014 contribution, transferred it to another institution, made no other contributions or distributions, and wants to recharacterize, it shouldn’t be an issue. Is this problematic only if the customer makes a partial transfer or has other contributions/distributions from the IRAs?

If you are disallowed from recharacterizations, what’s your next step? Should you remove excess as contributions?

Assume that the rollover was between two identical accounts (e.g. Roth IRA to Roth IRA or Traditional IRA to Traditional IRA)

Thanks in advance for any help.



Submitted by Alan - IRA critic on Tue, 2015-03-10 23:08

  • You are correct that this rule is confusing. The rule prevents changing the nature of an already completed tax free transfer. All recharacterizations are tax free transfers and therefore a recharacterization from one type of IRA contribution to another cannot be recharacterized back to the original IRA or to another IRA. Non reportable transfers between IRAs of the same type are also tax free transfers, and this rule would therefore prevent a transfer between two TIRA accounts being recharacterized into a Roth conversion. However, an initial conversion can be recharacterized because it is NOT considered a tax free transfer in the first place.
  • A rollover other than a conversion (see above re conversions) is a reportable but non taxable movement of funds between accounts. It is included here with the intent of disallowing such a rollover from being recharacterized as if it never occurred.
  • A direct trustee transfer between accounts will not prevent the corrective distribution of excess contributions, although it will result in permitted compromises in the required net earnings calculation.
  • The intent is obviously to limit recharacterizations to a single transaction and thereby prevent repeated recharacterizations of recharacterizations. But it does not prevent subsequent rollovers, corrective distributions etc. 

Submitted by abura98 on Wed, 2015-03-11 15:18

Hi Alan,Thank you for clarifying. I have one follow-up question. If I made a tax-free direct trustee transfer of my RIRA to another RIRA at another provider, and then wanted to recharacterize to a Traditional due to income limitations of a Roth, would this be permitted?Note that this is technically actually recharacterizing the original contribution made at the old provider (not the transfer itself). Thanks again for your quick response.

Submitted by Alan - IRA critic on Wed, 2015-03-11 16:58

Yes, you can recharacterize it. An IRS Reg addresses this. Reg 1.408A-5 Q 7 is copied below:

Q-7. If an amount is initially contributed to an IRA for a taxable year, then is moved (with net income attributable to the contribution) in a tax-free transfer to another IRA (the FIRST IRA for purposes of A-1 of this section), can the tax-free transfer be disregarded, so that the initial contribution that is transferred from the FIRST IRA to the SECOND IRA is treated as a recharacterization of that initial contribution? A-7. Yes. In applying section 408A(d)(6), tax-free transfers between IRAs are disregarded. Thus, if a contribution to an IRA for a year is followed by one or more tax-free transfers between IRAs prior to the recharacterization, then for purposes of section 408A(d)(6), the contribution is treated as if it remained in the initial IRA. Consequently, an individual may elect to recharacterize an initial contribution made to the initial IRA that was involved in a series of tax-free transfers by making a trustee-to-trustee transfer from the last IRA in the series to the SECOND IRA. In this case the contribution to the SECOND IRA is treated as made on the same date (and for the same taxable year) as the date the contribution being recharacterized was made to the initial IRA.

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