By Sarah Brenner, JD
A recharacterization is a tax-free transfer of funds from one kind of IRA to another. If you converted a traditional IRA to a Roth IRA and now are reconsidering, recharacterization allows you to undo the transaction and move the funds back to a traditional IRA. You can also recharacterize a tax-year traditional IRA contribution from a traditional IRA to a Roth IRA or vice versa. The Tax Cuts and Jobs Act does away with recharacterization for conversions done in 2018 and later, but the IRS has made it clear that 2017 conversions can still be recharacterized. Don’t miss out on this last chance to take advantage of one of the rare opportunities for a “do-over” in the tax code.
You may consider recharacterizing your 2017 conversion for many reasons. You might be having second thoughts about the tax bill. Tax reform has resulted in lower tax rates in 2018 for many taxpayers. Maybe you converted in 2017 when your rates were higher and now you would like a “do-over” at lower 2018 rates. You have the option of recharacterizing your 2017 conversion.
You can choose to recharacterize the whole conversion or just a portion. However, if you recharacterize just part of your conversion, you may not select the investments you want to recharacterize, only the dollar amounts. If you are looking to reconvert the fund you recharacterized, be aware also that there are restrictions. You may not reconvert the same funds until the beginning of the next taxable year following the year of the conversion, or if later, more than 30 days from the date of the recharacterization.
You can also recharacterize your 2017 tax-year IRA contributions. Recharacterization of contributions was not affected by tax reform and will remain available for 2018 and future years.
Maybe you contributed to a traditional IRA and later discovered the contribution was not deductible or maybe you contributed to a Roth IRA not knowing that your income was above the eligibility limits. You may recharacterize the nondeductible traditional IRA tax-year contribution to a Roth IRA and have tax-free instead of tax-deferred earnings if your income is within the Roth IRA contribution limits for the year. Or, if your Roth IRA contribution is an excess contribution because your income was too high, you may recharacterize that contribution to traditional IRA because there are no income limits for traditional IRA contributions.
If you have decided that a recharacterization is a good move for you, contact your IRA custodian. You will need to provide the custodian with some information to conduct the transaction such as the amount you would like to recharacterize and the date of the contribution or conversion. Most IRA custodians can provide you with a form to collect all the necessary information to complete a recharacterization. The IRA custodian will then directly move the funds you choose to recharacterize, along with the earnings or loss attributable, from the first IRA to the second IRA. This is a tax-free transaction but both IRAs report the transactions to you and the IRS. You will receive a 2018 Form 1099-R from the first IRA and a 2018 IRS Form 5498 from the second IRA.
Time is running out! The deadline for recharacterizing a 2017 tax-year contribution or conversion is October 15, 2018 for taxpayers who timely file their 2017 federal income tax returns. This is true even if you do not have an extension. You may need to file an amended 2017 federal income tax return if you recharacterize after you have already filed. Deciding whether recharacterizing is the right plan for you can be complicated. If you are considering this option, consult with an advisor who is an expert in this area.