How to Determine Loss or Gain on an IRA Recharacterization
If you convert your traditional IRA to another IRA, most commonly a Roth IRA, and later change your mind, you usually move the money back to your original IRA through a process known as recharacterization. One of the main reasons you might want to recharacterize your contribution is if the value of your Roth drops significantly after you make your conversion. If you make a full recharacterization, you do not have to calculate the gain or loss on the transaction. However, for all other recharacterizations, you must compute the gain or loss on the amount you recharacterize.
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Instructions
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Start with the IRS recharacterization formula. By having the formula in front of you before you begin your computation, it can help you visualize how each of the individual parts of the calculation work. To determine the gain or loss on your recharacterization, the formula is: net income = contribution x (adjusted closing balance - adjusted opening balance) / adjusted opening balance.
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Find your original contribution amount. The first step in the formula is to provide the amount of the contribution you originally made to your Roth IRA when you converted. For example, if you converted $100,000, that is your contribution figure, regardless of its current value. You usually can find your contribution amount on the statements from your financial services firm, or in your own personal financial records.
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Calculate your adjusted closing balance. The adjusted closing balance is essentially the current value of your Roth IRA, adding back in any distributions or conversions you made out of the Roth IRA during the period since your original conversion. For example, if you convert $100,000 to your Roth IRA, later take out $20,000, and your Roth value now is $110,000, your adjusted closing balance is the current $110,000 value plus the $20,000 you withdrew, or $130,000.
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Compute your adjusted opening balance. Take the opening value of your Roth IRA, which will be zero if you just opened a new Roth, and add the amount of your conversion to it. Add in any additional contributions or transfers you make to the Roth IRA before the time of your recharacterization.
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Follow the formula to determine the amount of your gain and loss. Take your adjusted closing balance, and subtract your adjusted opening balance. Divide this amount by your adjusted opening balance. Multiply this quotient by the amount of your original conversion to determine your net income or loss. In the example in which you converted $100,000 to your Roth IRA, withdrew $20,000, and have a current value of $110,000, the computation would be $100,000 x ($130,000 - $100,000) / $100,000, or a gain of $30,000.
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Tips & Warnings
Your IRA custodian will often calculate the gain or loss on your recharacterization for you, as the computation can be complex.
