Determining earnings/losses on IRA recharacterization

Forum|Forum|1 year ago
March 21, 2025
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I accidently made too much last year and am not eligible to contribute directly to a Roth IRA for 2024. I maxed out my contributions for the year beforehand so now I need to recharacterize the $7000 that I put in. I requested all the securities purchased with the contribution and the remaining cash be recharacterized, but the broker is contesting that the amount I am recharacterizing does not accurately reflect the net income according to formula of 26 CFR § 1.408-11.

The numbers here are made up, but the situation is basically that immediately prior to contributing the $7000 to the IRA the various securities in the account were worth $10,000. After contributing, I purchased 10 shares of Stock A for $600 each, leaving $1000 cash left. In the time since that purchase, the value of the assets in the account went from $17,000 to now $20,000 without any additional trading, dividends, deposits or interest (only market value increase of the held assets). The net income based on previous the formula would then be $1235.29 (but the earnings due only to the Stock A purchases are much less).

Now I have requested that the broker recharacterize by transferring the 10 shares of Stock A purchased after the contribution plus the remaining $1000 cash, since transferring the stocks purchased with the contribution captures all of the earnings attributable to the contribution. They are saying however that if I do this then they won't report the full contribution as having been recharacterized since the current market value of the shares of Stock A plus the $1000 doesn't equal $7000 + $1235.29 = $8235.29.

Surely this can't be correct, as recharacterizing $8235.29 would mean pulling income out of the account that is attributable to earlier years' contributions and not just the 2024 contribution. So what am I to do if they aren't going to provide the correct recharacterization amount on my tax forms?

dmertz

Employee

The gain/loss calculation is performed over the entire account balance, not any particular subset of investments in the account. The performance of any one investment by itself is only relevant in how it contributes to the overall performance of the account.

In your example, the account opening balance is $17,000 and the account closing balance is $20,000. That means that the $7,000 plus the attributable gain is simply:

$7,000 * $20,000 / $17,000 = $8,235.29

So $8,235.29 of value is the amount that must be moved from the Roth IRA to the traditional IRA to accomplish a recharacterization of the $7,000 contribution. It doesn't matter what investments in the account are moved in kind, or sold and the cash moved, to accomplish the movement of $8,235.29 of value. The result is a recharacterization of $7,000 of your 2024 contribution. (You are recharacterizing $7,000, not $8,235.29; $8,235.29 is the adjusted amount transferred.)

The Form 1099-R will have $8,235.29 in box 1 and $0 in box 2a and code R in box 7. Your explanation statement required to be included with your 2024 tax return will need to show that you recharacterized your entire $7,000 contribution and $7,000 plus an attributable gain of $1,235.29 was transferred from the Roth IRA to the traditional IRA to accomplish this.

It's usually simplest to do the transfer in cash by selling in the Roth IRA whatever shares you choose to sell, transfer the $8,235.29 in cash, then use the $8,235.29 of cash in the traditional IRA to purchase whatever you want.

twoo0Author

Thanks for your response. My issue isn't really what type of assets I'm moving, it's the value of the ones purchased with the contribution. Even though $8,235.29 is what the formula spits out, it doesn't reflect the reality of what gain is attributed to the contribution.

For example, the $3,000 gain that the account sees over the computation period is due to a $500 appreciation of the 10 stocks purchased with the 2024 contribution and a $2,500 appreciation of the stocks purchased prior to the contribution. More simply, that means the account would have gained $2,500 even if I made no contribution in 2024 and only $500 gain is reasonably attributable to the contribution. Since $500 is less than $1,235.29, recharacterizing based on the formula would involve pulling out gains that are obviously not attributable to the 2024 contribution. I assume that the excess would then be considered an early withdrawal or a similar taxable event.

So in this case do I just recharacterize the $7,500 ($7,000 contribution + $500 attributable gain), attach the explanation to the 2024 return, and disregard how the broker chooses to report the recharacterization on my future tax forms?