Timing of IRA Basis Isolation
Hello-
Client has an IRA with $100,000 ($20,000 of non-deductible contributions). If we roll their pre-tax portion to their 401k, at what point is the basis considered isolated?
For example, if the $80,000 check is in the mail can we invest their $20,000 and risk it going down? Or if account value in the IRA drops to $19,000 while the check is in the mail does that mean we are accidentally contributing basis to their 401k?
Thank you so much! Really appreciate the insight!
Permalink Submitted by Alan - IRA critic on Tue, 2021-12-07 18:01
The basis is isolated once the rollover check is written to the 401k. That said, if the plan declines to accept that rollover contribution for any reason, the basis is restored to the TIRA. For that reason, the rollover to the 401k should generally be accepted and deposited into the 401k plan before the taxpayer does a conversion or takes a distribution since declination of the rollover contribution would make such a distribution mostly taxable.
If the 20k is already in cash but will be converted, it won’t go down. It should be reinvested once in the Roth IRA or distributed to the client who plans to invest in a taxable account. The ability to convert IRA basis may not survive into 2022 as currently proposed in the BBB tax bill, so if a conversion is the reason for this 401k rollover, time is very short to complete these transactions.
What if the 20,000 were reinvested and then dropped in value to 19,000 before any conversion or distribution? This is a highly confusing issue. This does not mean that disallowed IRA basis was rolled into the 401k because reporting the above transaction on Form 8606 results in the unused remaining basis of 1,000 still assigned to the IRA on line 14. In addition Sec 408(H) that applies Sec 72 to IRA distributions describes a rollover to a qualified plan as a separate transaction, presumably not only for avoiding pro rating, but also separate in time from the end of year IRA basis determination. This means that IRA basis which cannot be rolled to a qualified plan would only be treated as occurring if the amount distributed to the qualified plan exceeded the pre tax balance at the time of the rollover distribution. If losses occurred after the rollover the result would just be carry over basis remaining assigned to the IRA.