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After all the hoopla around Roth conversions in 2010, now is the time to consider whether or not a re-characterization is in your future..

If you made a Roth IRA conversions last year (when all the media were encouraging you to do so), you may rue your decision now that tax time has arrived.  Forbes recently ran a reminder that it’s not too late to undo your conversion decision.   You can still “re-characterize” the conversion and put the money back in your traditional IRA, as if nothing had ever happened.

But why re-characterize? Here is the example Forbes used:

Let’s say you converted $100,000 to a Roth IRA in 2010 and you are ready to pay the tax on your 2010 return (you elected out of the spread to 2011 and 2012).  Except that now, your investment in the Roth IRA has dropped in value to only $50,000 – and you still owe tax on the conversion of $100,000!  Yikes – that’s just totally wrong!

Re-characterization offers a do-over of the conversion itself, and indeed, erases it as far as the IRS is concerned. Re-characterization will move the funds back into the original traditional IRA and the IRS only sees it as the movement of the original amount minus losses, rather than as a separate interaction. If you suffered net loss on those assets re-characterization will not reverse your losses, but you can get rid of the insult-on-top-of-injury tax liability.

            There are some tricks to the issue not covered by Forbes’s reminder, but in addition to consulting your advisor Forbes suggests consulting the IRA Owner’s Manual.



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