Roth IRA conversion: There’s still time to recharacterize

This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. | Washington Business Journal

If you converted a regular IRA into a Roth in 2010 and the value of your Roth IRA has fallen, you may want to consider undoing — or “recharacterizing” — the transaction. This is one of the few times the rules allow you turn back the clock and wipe out a prior transaction in order to avoid a higher tax bill.

The original conversion from a regular IRA to a Roth is treated as a distribution from a regular IRA followed by a contribution to a Roth IRA. As such, the amount “distributed” (less any portion of the IRA that represented non-deductible contributions, prorated across all accounts if there are multiple IRAs with non-deductible contributions), is taxable as ordinary income in the year of distribution. For 2010 conversions only, the taxpayer has the option to take all of the income in 2010 or to spread the income equally over 2011 and 2012.

The taxable amount is determined on the day of the conversion even though the value today may be substantially lower. So, for example, if you converted a $100,000 IRA into a Roth and the value today is $80,000, you still owe the tax on the original $100,000. You can avoid this result by contacting your IRA administrator and asking to recharacterize the account back to a traditional IRA.

The deadline for recharacterizing is the tax filing due date, including extensions, or Oct. 15 following the year of conversion. For 2010 conversions, the deadline is Oct. 17 because the 15th falls on a Saturday.

Taxpayers have the option to recharacterize a conversion even if taxes have already been filed for 2010 as long as it is before the October 17th deadline. In order to get back the tax paid on the conversion, as well as the interest owed to you by the IRS, you will need to file an amended return.

Should you wish to reconvert your traditional IRA to a Roth IRA at a later date, the IRS allows you to do so as long as you wait until the later of 30 days after the recharacterization or the beginning of the year following the year of the initial conversion to a Roth IRA. Of course, there is a risk that your IRA could appreciate to a value even higher than your original conversion value, so consider carefully whether to recharacterize a Roth that has depreciated only minimally from its conversion-date value.

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