How to Convert a Traditional IRA to Roth With Capital Losses
Converting a traditional IRA into a Roth IRA is an investment tactic to utilize if you can benefit from tax-free growth over time and can afford to pay the taxes on the converted amount. There are two scenarios where a capital loss may affect your Roth IRA conversion. The first is if the Roth IRA value goes down after you convert. The other is if you have other capital losses outside of the IRA in the year you convert.
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Instructions
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Roth Value Declines - Recharacterization
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Contact a tax advisor to see if recharacterization is appropriate for you. Recharacterization is where you take a converted Roth IRA and re-establish it as a traditional IRA. This can be done if the value of the IRA has dropped and you want to re-establish it as a traditional IRA to later have a lower tax consequence on it.
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Confirm that you have not passed the deadline to recharacterize. You must file the paperwork by the tax return deadline in the year following the conversion. For example, if you converted in December of 2010, you must recharacterize by April 15, 2011 unless you filed for an extension, which would then become your deadline.
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Contact the Roth custodian and request paperwork to recharacterize the IRA. Fill it out and submit it before the tax deadline.
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Report the recharacterization with your taxes on Form 8606 with your Form 1040.
Outside Capital Loss - Offset Taxes
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Contact your tax advisor. Review your current income tax bracket and whether or not a conversion is the best solution for your needs.
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Calculate the tax liability for converting a traditional IRA. Conversions made in 2010 are allowed to pay the taxes over the 2011 and 2012 tax years.
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Determine outside capital losses you may have: stocks, real estate, private equity investment. You are allowed to deduct up to $3,000 per year in income tax with capital losses and carryover the balance for future years.
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Contact the IRA custodian and request conversion paperwork. Fill out the paperwork and submit it.
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File Form 1040, Schedule D to account for the conversion and offset it with capital losses.
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References
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