I made a $7500 deductible IRA contribution for 2023 in January 2023, and have been recharacterizing positions that have done well in the past 6 months, rather than converting stocks that are still down from when I bought them (though I did a few of those too, and a lot of them in 2022). Now my broker is telling me that when recharacterizing a contribution and having stocks (rather than cash) transferred to my Roth, I don't have to restrict myself to only shares bought after the contribution was made. Is this true? Can I recharacterize positions I bought last year, or even decades ago, as long as the total (I'm not sure how they'd calculate earnings) of the recharacterized amount is less than or equal to the contribution?
In some cases, I've had 500%+ gains in stocks over the years - so if I wanted to recharacterize say $3000 of my 2023 contribution, and have 10 shares of stock that's currently worth $290/share transferred to my Roth, with the remainder taken from cash, would they transfer all 10 shares plus $100 in cash? Or would they look at the shares and see I paid $50 each for them, transfer all 10 shares for $500 in contributions, plus $2500 cash to make the $3000 recharacterization, and consider another $2400 to be nontaxable earnings? I know that's an oversimplification, it depends on the value of the account before the recharacterization, but I'm just wondering how it works when 1. Something has had a huge gain since the original contribution and 2. The stocks you're asking to transfer to the Roth are ones that were bought before the contribution you're trying to recharacterize was even made.
I want to be very specific about terminology.
"Recharacterize" as regards IRAs is a specific term that means you treat a contribution to one kind of IRA as having been made to a different kind of IRA instead. For example, if you make a contribution to a traditional IRA and latter decide you would prefer it had been made to a Roth IRA, you can "recharacterize" the contribution instead of withdrawing it from the IRA and making a new contribution to the Roth.
If you are buying and selling investments within an IRA account, that is not "recharacterization." There are no capital gains implications of buying and selling shares inside an IRA. Nothing that happens in an IRA has any tax consequences, the only thing that counts is what you withdraw. Your withdrawals are taxed as ordinary income, no matter where it came from. If you have a huge gain on one stock and you sell it for another stock, that's not taxed as a capital gain. You just have more money to withdraw, and you only pay tax on what you withdraw.
Converting money from a traditional IRA to a Roth IRA is a conversion, it is also a specialized type of rollover. It is the same broad concept as withdrawing money from the traditional IRA, paying the income tax, and then depositing it in the Roth IRA (although the laws on how you do a conversion are quite different than actually making a withdrawal). Normally, the only thing that counts is the money. If you convert $10,000 from an IRA to a Roth IRA, you pay tax on $10,000. It doesn't matter what you sold to get out of the IRA or what you bought in the Roth IRA, a $10,000 conversion is a $10,000 conversion.
It seems you are trying to monkey around with your cost basis. But cost basis is irrelevant in an IRA or Roth IRA. If you shares of ABC for $10 each inside your IRA and it is now worth $1000, you will pay tax on $1000 when you withdraw it (because the $10 was contributed tax-free). If you sell the ABC stock and buy 1 share of XYZ at $1000/share, and then sell it, you still pay tax on $1000, because that's the amount of cash you withdraw.
Now, it appears you are trying to move specific stocks, rather than just moving money. But you aren't "recharacterizing your positions". The word recharacterize only applies to deciding that your annual contribution should have gone some place different than you first intended. You want to do a Roth conversion with specific stocks, instead of converting them to cash first.
If you want to do a Roth conversion that keeps your current share position instead of selling, getting cash, and rolling over the cash, there may be specific rules on which shares your can sell or how the conversion is calculated. I will ask for more help. But I'm not sure that you understand how investing inside an IRA (including Roth IRAs) is very different than investing outside an IRA.
I'm aware of the difference between recharacterizing a current tax year contribution (you have up until the date you file, including extensions) and converting. I was very surprised to hear from Schwab that I did not have to limit my recharacterization to shares I'd bought since the contribution in January (you can choose to take your $ amount recharacterization by moving positions to your Roth, cash, or a combination). So far I have just requested my recharacterizations by moving stocks I've bought since January, and a small amount of cash as necessary to make up the difference. But now since I was told this earlier today, I'm wondering if I can transfer shares that have gone up even more, that I bought long ago, and how they would figure the earnings on those. I know the formula is Net Income (earnings treated as being earned in the Roth) = Contribution (recharacterized amount) * (Adjusted Closing Balance - Adjusted Opening Balance)/AOB. My first recharacterization used the AOB of $0 in the numerator and $7500 in the denominator, and the ACB was the entire account value including earnings on the day of the recharacterization. But now I don't know what the AOB would be months later, when I've already recharacterized over $4700 but stocks have gone up even more. I recharacterized a small amount ($1200) last week and they figured NI was about $120 so transferred $1320. But I don't know what they used for AOB, though I could probably look at historical data and figure out what ACB was that day.
Please refer to Worsheet 1-3 Determining the Amount of Net Income Due
to an IRA Contribution and Total Amount To Be Recharacterized
in IRS Pub 590-A
It depends only on when you made the contribution that you want to recharacterize, and when you do the recharacterize (i.e. the custodian executes your request).
the gains and losses of various securities in your account are not going to be a parameter that can be used to your advantage.
That's the same formula I gave above. the problem is trying to determine the AOB (and maybe the ACB since you have to account for previous recharacterizations). At any rate, I think the net income is just going to be that % of earnings allocatable to the amount I'm trying to recharacterize now (in my example, $3000) that was earned SINCE the contribution was made. So I made the contribution in January, the closing value will only include net earnings on the whole account from January until now, so I *think* that if the account value was 0 on January 1, and $7500 immediately afterward, and now (after some previous recharacterizations) it's $3100, you'd have to look at it and say add those recharacterizations (let's say it was $4700 including $420 of earnings) so the ADJUSTED closing value would be $3100+4700= $7800, so that was $300 worth of earnings, and they already included $420 earnings in previous recharacterizations as of last week, so there are no earnings attributable to the contribution that's remaining in the account. Since I put in $7500 and took out $4280 ($4700-$420 earnings), if I ask for $3000 to be recharacterized now, there is no net income, and my total recharacterizations would be $7280 leaving only $220 as my traditional IRA contribution, even though the account balance after the last recharacterization would be $100 - so I lost $120?
Recharacterizations are based on dollar value and the overall change in dollar value of the IRA, not in the performance of any particular investment within the IRA. The recharacterization can be accomplished either in cash or by an in-kind transfer of any shares having the required dollar value.
Capital cost basis has no meaning within an IRA. Ignoring any brokerage transaction fees that might apply, there is essentially no difference between doing an in-kind transfer to accomplish the recharacterization from a traditional IRA to a Roth IRA and selling the shares within the traditional IRA, transferring the cash to the Roth IRA and repurchasing the shares in the Roth IRA. The only difference with doing it in cash is that the sales price will likely be a bit different from the repurchase price. Either way, a recharacterization is a nontaxable transfer of a particular dollar value.
If you choose to do an in-kind transfer, it would make sense to choose shares that have the best chance for future appreciation since that appreciation will be tax free (once your Roth IRAs are qualified) in the Roth IRA instead of tax deferred in the traditional IRA. Past performance is not a factor.
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