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Taxation on IRA to Roth conversion


Mephistopheles
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Hi all,

 

Quick question regarding this topic.

 

Scenario: Let's say I converted $25,000 out of a $50,000 IRA to a Roth. I owe Federal taxes on the full $25,000, because it was a tax-free contribution to start with, and tax-free growth. For state taxes, I only owe money on the growth, because the contribution was taxed initially. The way to figure out amount of the conversion is the contribution, that I don't have to pay state taxes on, is figure out what % of the total account the $25,000 was.

 

Now my question is, do I take the account value on the day of the conversion, in this case $50,000? Or do I take something like end of the year value, including the $25,000 I converted? For example, if the account at the end of the year post conversion is $40,000, then the total would be $65,000. So would it be $25k/$65k in that case, $25k/$50k?

 

Hope I'm not confusing anyone. I tried Google but couldn't find a clear cut answer. I figure people on this board have converted many times so hoping someone knows.

 

Thanks for reading!

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I am hardly an accountant or expert in tax issues.  My reading of re-characterization suggests that it is initial value at time of conversion, unless you reverse the conversion. Please check below article.  Also, may be you can call your broker and talk about re-characterization.

 

https://www.fidelity.com/viewpoints/retirement/how-to-reverse-a-roth-conversion

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Yea, for instance. I had a holding that dropped 40% (bought too soon) and wanted to keep it, but didn't really want to keep adding more. So I just converted it to the Roth. Initial cost basis say was $5,000, but on the day of conversion, it was only $3,000, which is the tax basis reported to the IRS. Hope and strategy is that it will recover and grow taxfree in the Roth.

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Guest longinvestor

Yea, for instance. I had a holding that dropped 40% (bought too soon) and wanted to keep it, but didn't really want to keep adding more. So I just converted it to the Roth. Initial cost basis say was $5,000, but on the day of conversion, it was only $3,000, which is the tax basis reported to the IRS. Hope and strategy is that it will recover and grow tax free in the Roth.

 

If it works, this is a good strategy, pay taxes on a lower cost basis and reap all gains tax free. You can always re-characterize back to an IRA by October of the next year if it is a mistake, that is, if the account loses more value. Anyone thinking long term should at least consider something like this. Roth is like vitamins in retirement, especially the out-years. If you do this early in life, you'd be doing great.

 

Should add that the year 2010 was a great time to have done this given a) low valuations then. b) uncle Sam gave us two years to pay the conversion tax. I went a bit overboard on the amount and the tax bite was hard but in hindsight it worked out. I remember telling everyone I knew to do this back in 2009-10.

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