Since I am in the throes of tax season, I wanted to put together a quick article about IRA recharacterizations. A recharacterization occurs when you make a contribution to a Traditional IRA or Roth IRA and you want to move it to the other type of account.

Here are four situations in which you may want to consider a recharacterization:

  • You contribute to a Roth IRA but later find out that you made too much money to contribute to a Roth IRA and so you want to recharacterize the contribution to a Traditional IRA.
  • You intended to effect a backdoor Roth IRA but accidentally put the money into the Roth IRA on the front-end and need to recharacterize the contribution to a Traditional IRA.
  • You made a Traditional IRA contribution that you later find out you cannot deduct, but you are within the income threshold to make a Roth IRA contribution, so you want to recharacterize the contribution to a Roth IRA.
  • You converted Traditional IRA monies into multiple Roth IRA accounts as described here, and you want to recharacterize back to your Traditional IRA the Roth IRA accounts that performed poorly in the interim.

The most important thing to understand is that your deadline to complete the recharacterization is your tax filing deadline with extensions.  So for contributions to an IRA or Roth IRA in 2016, the deadline is October 15, 2017. If the recharacterization is not timely completed, then you will likely be stuck with the tax consequences of the initial IRA or Roth IRA contribution.

When a recharacterization is completed before the filing deadline, there is generally no tax effect to moving the original contribution from the Roth IRA to the Traditional IRA or vice versa. It is as if the original contribution never happened. So in the first example above, your tax return ultimately treats the original Roth IRA contribution has if it never occurred but you instead made a Traditional IRA contribution. If you could deduct the Traditional IRA contribution had you originally made it, then you would be able to in this situation as well (although if you make too much money to contribute to a Roth IRA then you make too much money to deduct a Traditional IRA contribution).  If you had gains in the account during the time between the original contribution and the recharacterization, then a portion of that gain needs to be moved over as part of the recharacterization.  This article has a good description of the formula for calculating the gain and some examples.

-Richard

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