Does a Roth IRA to Roth IRA transfer affect basis on Form 8606?

[cmorristax]

Let's say I contribute $6,000 to my Roth IRA at Fidelity. I put it into a mutual fund and it goes up to $7,000. I then transfer the mutual fund position to my Roth IRA at Schwab. Does my Roth IRA basis (for Part III of Form 8606) go up by $1,000?

The IRS's instructions say: 

• Increase the amount on line 22 by any amount rolled in from a designated Roth account that is treated as investment in the contract.

[dmertz]

No, your basis does not change.  It's still $6,000.

This is not a rollover from a designated Roth account.  A designated Roth account is an account in a qualified retirement plan like a 401(k).  A Roth IRA is not a designated Roth account.  Even if the $6,000 contribution had been made to a designated Roth account, the earnings in that account are not part of the investment in the contract.  The investment in the contract is $6,000, the amount you paid into it.

The only time that gains are treated as investment in the contract is when the investment is in a designated Roth account in a qualified retirement plan like a 401(k), you've reached age 59½ or become disabled and have had the designated Roth account for at least 5 years (making all distributions from this account tax-free qualified distributions) and you roll the money over to a Roth IRA.

[cmorristax]

Let's say I contribute $8,000 to a qualified Roth 401(k), put it into a mutual fund, the value goes to $9,000, I'm 47 years old, the 401(k) is 3 years old, and a do a direct rollover to my Roth IRA. Do I add $9,000 to my Roth IRA basis?

From what I've read elsewhere on the Web, the answer must be yes. This is because earnings and contributions in a Roth 401(k) come out at the same time. Or let's say I contributed $40,000 total over a few years, and then transferred one mutual fund position valued at $12,000 (that includes some earnings in that position). Would I add $12,000 to my Roth IRA basis? 

[dmertz]

Let's say I contribute $8,000 to a qualified Roth 401(k), put it into a mutual fund, the value goes to $9,000, I'm 47 years old, the 401(k) is 3 years old, and a do a direct rollover to my Roth IRA. Do I add $9,000 to my Roth IRA basis?

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No, only $8,000 gets added to your Roth IRA contribution basis.  The Roth 401(k) is not a qualified Roth 401(k) in this case; your example is self-contradictory in this respect.

The $1,000 of gains would only get added to your Roth IRA contribution basis if the distribution from the Roth 401(k) would have been a qualified distribution.  For the Roth 401(k) to be a qualified Roth 401(k) you must be age 59½ or over or disabled and the 5-year holding period for this Roth 401(k) is required to have been completed.

[dmertz]

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Or let's say I contributed $40,000 total over a few years, and then transferred one mutual fund position valued at $12,000 (that includes some earnings in that position). Would I add $12,000 to my Roth IRA basis? 

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The information in this example is incomplete in that it does not state the value of the Roth 401(k) prior to the distribution from the Roth 401(k).  Because the distribution is not a qualified distribution, the distribution consists partly of earnings and partly of contribution basis (unless there have been no investment gains in the Roth 401(k).

If we add to the example that the value of the Roth 401(k) is, say $50,000, 20% of the Roth 401(k) is gains, so 20% of the $12,000 distribution from the Roth 401(k) is gains and 80% is contribution basis.  That means that the rollover of the entire distribution to the Roth IRA adds 0.8 * $12,000 = $9,600 of contribution basis to your Roth IRAs.

If the rollover is less than the full amount of the distribution, the portion rolled over is treated as coming first from the taxable portion of the distribution.  This means that the first $2,400 rolled over to the Roth IRA does not add any contribution basis to the Roth IRA and only additional amounts rolled over add contribution basis.

[cmorristax]

One final question: let's assume I do a direct rollover of $12,000 from Roth 401(k) to Roth IRA, and $9,600 is considered contributions and $2,400 is considered earnings. I'm under 59½, and my 401(k)—but not my IRA—is less than 5 years old. Is any portion of this transaction taxable?

[dmertz · Accepted solution]

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let's assume I do a direct rollover of $12,000 from Roth 401(k) to Roth IRA, and $9,600 is considered contributions and $2,400 is considered earnings. I'm under 59½, and my 401(k)—but not my IRA—is less than 5 years old. Is any portion of this transaction taxable?

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None of it is taxable.  The earnings in the Roth 401(k) simply become earnings in the Roth IRA.

Note that the establishment date of the Roth 401(k) does not carry over to the Roth IRA.  The 5-year period for qualified distributions from a Roth IRA begins at the beginning of the year for which the first contribution is made to the Roth IRA.  If this rollover establishes the individual's first Roth IRA, the 5-year period for qualified distributions from the Roth IRA begins on January 1 of the year in which the rollover is received by the Roth IRA.