What exactly is cost basis for a traditional IRA?

[DanaB27]

Please be aware, the basis and value of a traditional IRA are two different things. The basis is nondeductible contributions (after-tax contributions). The value at the end of the year you find on your end of the year statement, it consists of the contributions, earnings, and rollovers.

The calculation would be like shown below (this is done on Form 8608):

Value in traditional, SEP, and SIMPLE IRA on Dec 31, 2021              $20,000

Distributions                                                                                            $0

Conversions to Roth                                                                               $  5,000

Total                                                                                                          $25,000

Basis $5,000  

$5,000/$25,000 = 0.2

Nontaxable Conversion part $5,000 x 0.2 = $1,000

Therefore $4,000 are taxable.

The basis of $4,000 can be used for future distributions and conversions.

As you can see from the calculation it is important to keep track of your basis on Form 8606 through the years. Furthermore, because of this allocation, a backdoor Roth only works correctly if all traditional, SEP, and SIMPLE IRA are empty before starting making contributions using the backdoor Roth technique.

You mentioned that you recharacterized a 2020 contribution. I assume your wife had contributed to a Roth IRA for 2020 and then it was recharacterized as a traditional IRA and made nondeductible. Therefore, you would have a $2,000 basis from the prior year which you will have to enter when TurboTax asks (steps 6 and 7 below). You should be able to see your basis on the 2020 Form 8606 line 14.

1. Click on "Search" on the top right and type “1099-R”
2. Click on “Jump to 1099-R”
3. Click "Continue" and enter the information from your 1099-R
4. Answer questions until you get to “Tell us if you moved the money through a rollover or conversion” and choose “I converted some or all of it to a Roth IRA”
5. On the "Your 1099-R Entries" screen click "continue"
6. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years.
7. Answer the questions about the basis and value

To enter prior-year basis screen:

To enter the end of the year value screen:

[dhuynh44]

@DanaB27 

Hey Dana, this might be the exact issue giving me headache. See below:

“You mentioned that you recharacterized a 2020 contribution. I assume your wife had contributed to a Roth IRA for 2020 and then it was recharacterized as a traditional IRA and made nondeductible. Therefore, you would have a $2,000 basis from the prior year which you will have to enter when TurboTax asks (steps 6 and 7 below). You should be able to see your basis on the 2020 Form 8606 line 14.”

So yes, my wife lets say contributed $1000 to Roth in 2020 in error.  However, at the end of the year 2020 her basis was exactly $0.  Then in  March 2021, we recharacterized this $1000 for 2020 back to traditional, then converted back to Roth in March 2021 as soon as it was able to.  So having said this, and there was no basis at end of 2020, would the $1000 (now treated as nondeductible in traditional IRA) be truly a basis at end of 2020 or just part of our nondeductible contribution when we amend 2020?

Thank you

[DanaB27]

Yes, since you recharacterized the 2020 Roth contribution as a traditional IRA contribution and made them nondeductible you will have a basis reported on Form 8606. You should have entered the recharacterization on your 2020 tax return like the steps below.

You will enter the recharacterization when you enter the contribution to the Roth IRA

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions”
3. Click on “Jump to IRA contributions"
4. Select “Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution
6. Enter the Roth contribution amount 
7. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount (no earnings or losses)
8. TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.
9. On the screen "Choose Not to Deduct IRA Contributions" answer "Yes" (if you are thinking about doing a backdoor Roth. If you have a retirement plan at work and are over the income limit it will be nondeductible automatically and you only get a screen saying $0 is deductible)

[dhuynh44]

@DanaB27 

Hi Dana,

So when I amend 2020, I do not necessarily need to report this 2021 1099-R with recharacterization (basis + gains) per se on 2020 but just enter the amount we recharacterized (without gains)?   So in the end of December 31, 2020 we will have a basis of this recharacterized contribution?  How will this affect us paying taxes on this amount even though it’s after tax and there was actually $0 in this account at end of year?

Do we have to report this recharacterized amount as described above (2021 recharacterized for year 2020 basis with gains or losses) anywhere on our 2021 return?  

Sorry for the confusion and thank you.  

[loupoandl]

I agree with Diane who told you that you have a 0 basis for the traditional IRA.  You had a basis that equaled what you paid into the traditional IRA, but you reduced it to 0 when you converted.

[dhuynh44]

@DanaB27 

“Please be aware, the basis and value of a traditional IRA are two different things. The basis is nondeductible contributions (after-tax contributions). The value at the end of the year you find on your end of the year statement, it consists of the contributions, earnings, and rollovers.”

Hi, this value is basically what is in the account at end of year 2021 correct?   This does not include what we converted to Roth, just whatever is sitting in the traditional IRA (should all be pretax in our situation)

[dhuynh44]

@loupoandl 

So I’m truly confused now, this $2k that we recharacterized in 2021 for year 2020.  From my understanding we made this a nondeductible contribution when we recharacterized, and we converted it to Roth in 2021.  Does this conversion in 2021 make our end of year basis for 2020 $0 or $2k since the conversion was done in 2021, for year 2020?

I think from our 1099-R for 2021 this conversion amount that was recharacterized as mentioned above was included in Roth conversion for year 2021.   Thank you!

[DanaB27]

Yes, the value on December 31, 2021, is the value of what is in the account at end of the year 2021. This will be on your end-of-the-year statement. 

Yes, this does not include what you converted to Roth during 2021, it is just whatever is left sitting in the traditional IRA on December 31, 2021.

Please be aware, that this value left in the traditional IRA will have part of your non-deductible basis (nontaxable part) and part pre-tax contributions plus earning (taxable part). You can't just choose to take out the nontaxable basis part and leave the taxable part in the account. Each distribution/ conversion going forward will have a taxable and nontaxable part until you empty the traditional IRA completely (=$0 at the end of the year). If you do that then you can start fresh and use the backdoor Roth method correctly and make nondeductible traditional IRA contributions and convert them tax-free to a Roth account. 

No, the recharacterization of a 2020 contribution is not reported on your 2021 return. This will only go on your 2020 tax return.

@dhuynh44

[dhuynh44]

@DanaB27 

Thanks, what are your thoughts on this comment?

“I agree with Diane who told you that you have a 0 basis for the traditional IRA.  You had a basis that equaled what you paid into the traditional IRA, but you reduced it to 0 when you converted.”

You are saying I have a $2k basis for end of year 2020 for the amount I recharacterized in 2021 for year 2020, and ended up converting it in 2021.  Since I converted it in 2021, does the conversion count for year 2020 or 2021?  If the $2k in Basis holds true, how does this affect paying taxes in either 2020 or 2021?

What we were doing for our traditional, as recommended by my financial institution, was convert the after tax dollars we contributed right away to Roth, as these were just held as cash and not in any stocks or funds.   Essentially with the exception of $500 after tax remaining in the traditional, we converted all of the after tax dollars to Roth.  I want to ensure we input this correctly as to not pay any unnecessary taxes for and pretax amount still sitting in our traditional.  Thank you 

[DanaB27]

In regards to the comment, when Diane answered the original question "making a nondeductible contribution in 2020 and then convert right away" then yes, your basis from prior years would be $0. But added information in your posts at a later time, stating you recharacterized a 2020 Roth contribution (this will be reported on your 2020 tax return) that you converted in 2021. Therefore, you have a prior year basis to enter on your 2021 return.

If you have a prior year basis of $2,000 plus the 2021 nondeductible contribution of $6,000 then you have a total basis of $8,000 before converting.

Assuming you have $20,000 value left in the traditional IRA on December 31, 2021:

Value in traditional, SEP, and SIMPLE IRA on Dec 31, 2021              $20,000

Distributions                                                                                            $0

Conversions to Roth                                                                               $  8,000

Total                                                                                                          $28,000

Basis $8,000  

$8,000/$28,000 = 0.286

Nontaxable Conversion part $8,000 x 0.286 = $2,288

Therefore $5,712 are taxable.

The leftover basis of $5,712 can be used for future distributions and conversions.

Please be aware, that the recommendation that your financial advisor gave you only works if no Traditional, SEP, or SIMPLE IRA  account exists. But your wife moved the funds from the 401k to the traditional IRA and then the backdoor Roth will not work smoothly as intended.

@dhuynh44 

[dhuynh44]

@DanaB27 

Thanks for the info, and you have been such a big help.  So even though that $8k that was converted was already after tax dollars, we have to essentially pay more tax on it bc we had pretax money left in our traditional?  If so, that’s a bummer.  

“The leftover basis of $5,712 can be used for future distributions and conversions.”

So even though that $8k that was converted was already after tax dollars, we have to essentially pay more tax on it bc we had pretax money left in our traditional?  If so, that’s a bummer.  

So going forward, if we have converted everything over after tax and all that is left is pretax in traditional IRA ($0 after tax in traditional) where and when would this $5712 be needed for future taxes purposes?  Can you please explain how it is leftover basis if it’s been all converted?  Thanks

[DanaB27]

Yes, you will have to pay taxes on part of the conversion because of the pre-tax amount in the traditional IRA. 

In the future, when you take a distribution/ make a conversion then part of the $5,712 leftover basis would be allocated to that event and that part would be tax-free. So you will get to use the basis later and not lose your after-tax money.

So if you would empty the traditional IRA account then $5,712 of that distribution/conversion would be not taxable because of the leftover basis of $5,712.

@dhuynh44

[dhuynh44]

@DanaB27 

This makes sense.  I understand if we ever clear the account the $5712 comes into play, but how would it come into play in 2022 if we ever converted $6k from traditional to Roth (which we will avoid doing again with $ in the account).  But just curious.  

Does this $5712 need to be reported on any tax returns for 2021 or 2022 if we do not do this again in 2022?

Also, you calculated the $5712 for us as an example.  Would we need to make this actual calculation ourselves for year 2021, or will TurboTax give us this remaining basis for us, and if so which line is it?

thank you,

[DanaB27]

If you make a nondeductible contribution of $6,000 in 2022 and convert it in 2022 and assume  (unrealistically) that the value didn’t change on Dec 31, 2022, the calculation would be like this:

Value in traditional, SEP, and SIMPLE IRA on Dec 31, 2022              $20,000

Distributions                                                                                            $0

Conversions to Roth                                                                               $  6,000

Total                                                                                                          $26,000

Basis $5,712 + $6,000 = $11,712  

$11,712 / 26,000 = 0.45

Nontaxable Conversion part $6,000 x 0.45 = $2,700

Therefore $3,300 are taxable.

The leftover basis of $9,012 can be used for future distributions and conversions.

Your basis for 2021 "$5,712" will be reported on line 14 of Form 8606 but TurboTax will make all these calculations for you on Form 8606 for the tax year 2021 when you answer all the questions in the interview.

Next year, all you have to do is check line 14 on Form 8606 from your 2021 tax return and enter this amount in your 2022 tax return when TurboTax asks about the prior year basis.

[dhuynh44]

@DanaB27 

Hi, I believe I am slightly confused as to what to enter for my 2021 after tax contributions (basis) and want to make sense of all the moving parts.  Are you able to provide me with coke guidance using the examples below?

I think my main question is this using the same examples:  

$3000 contributed in 2020 and converted to Roth directly in 2020

$2000 end of year basis for 2020 (what was recharacterized in 2021 for 2020 before gains)

$5000 contributed in 2021 and converted directly to Roth in 2021

$2000 basis end of year 2020 converted to Roth in 2021 for a total of $7000 converted to Roth in 2021

Assuming the above all makes sense, what would my total 2021 after tax contributions be to enter for 2021?  Thank you!