1

In regular brokerage account, the cost basis increases by reinvestment of investment income.

I guess it is the same case in Roth IRA? I am not sure, because I don't know if there is some rule that says no for reason that I don't know.

If it is the same case, since tax forms such as 1099-xxx do not report investment income from Roth IRA as long as they are not withdrawn from the Roth IRA, I think the only source for updating cost basis is the monthly statement of the Roth IRA?

Thanks!

6

Earnings on investments within your Roth IRA that are reinvested within your Roth IRA do not increase your basis in your Roth IRA.

Your basis in your Roth IRA is the total amount of post-tax money that you have contributed to your Roth IRA. There are three categories here.

  • The amount that you have contributed directly to your Roth IRA over the years. Remember that you did not get to deduct these contributions on your tax returns and so this is post-tax money.
  • Any basis that you had in your Traditional IRA account that you converted and transferred into your Roth IRA. This basis is the sum of all the nondeductible contributions you made to your Traditional IRA (and reported on Form 8606, I hope). This is post-tax money since you didn't get to deduct these contributions on your tax returns.
  • Any other amounts that you converted from your Traditional IRA and transferred to your Roth IRA.
    These are typically the tax-deductible contributions that you made to your Traditional IRA plus the tax-deferred earnings (or losses) within the Traditional IRA. You declared these amounts as taxable income and paid income taxes on them as part of the conversion and transfer process and so this is also post-tax money.

Your basis is post-tax money, and you are entitled to withdraw all or any part of it from your Roth IRA without having to pay income tax all over again on the amounts. The first two categories have the advantage that they can be withdrawn at any time without incurring the 10% tax penalty for early withdrawal, but the third category will incur the 10% penalty for early withdrawal if it is withdrawn too soon. Can you play games with the amounts and say that you are withdrawing one kind of money and not the other? No, you cannot. The IRS rules say that the amount withdrawn is counted against the first category (direct contributions), and when all that money has been withdrawn, the rest is counted against the second and third categories in order of seniority: the oldest amounts come out first. Any earnings within your Roth IRA are deemed to have been withdrawn only after your entire basis (remember: basis means post-income tax money that you contributed to your Roth IRA) has been withdrawn completely. These earnings are tax-free and penalty-free as long as they are a Qualified Distribution (meaning after the later of 5 years after account was opened and age 59.5 or meeting one of the exceptions) but are subject to both income tax and 10% penalty if they are not Qualified Distributions

To forestall your next questions, I remind you that

  • In the eyes of the law, you have only one Roth IRA, and so taking earnings from your Roth IRA investment account in Brokerage A and investing those in your Roth IRA investment account in Brokerage B does not count as a contribution and does not increase your basis. This case is covered by the block-quoted sentence in bold face above because you have only one Roth IRA in the eyes of the law, and the money transferred over from Brokerage A to Brokerage B is entirely within your Roth IRA.

  • You can update "your basis" as per your understanding using your monthly IRA statements in your personal money management software program so that you feel good (or bad) about your Roth IRA investments, but doing so does not change what the law regards as your basis in your Roth IRA.

  • There is no constitutional requirement that tax laws have to have a rationale, or be reasonable according to what you or anyone else thinks is reasonable, or agree with what you have recorded in your personal money management program as "your basis" in your Roth IRA.

  • If you don't like the law, don't ask in this forum why the law is the way it is; we have no answer that will satisfy you. Instead, write to your Congress-critter demanding that the law be revised to read the way you want it to read. If your Congress-critter does not agree to do what you want, an election is coming up in a few months' time.

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  • 2
    One point on the Roth 'Basis' - The deposited amount can always be withdrawn tax/penalty free. Growth can not, not can the funds from Trad IRA conversions. So, whatever terminology one wishes to use, there are multiple numbers to track, and if asked what the basis is, the correct answer is "for what purpose?" – JTP - Apologise to Monica Jun 11 '12 at 16:56
  • @JoeTaxpayer: "not can the funds from Trad IRA conversions" Not true. Non-taxable parts of the conversion can be withdrawn tax and penalty free at any time. Taxable parts of the conversion can be withdrawn tax and penalty free after 5 years. – user102008 Jun 11 '12 at 19:01
  • I chose my words carefully (aside from the typo - the second 'not' was supposed to be 'nor'). The delay of 5 years is a "not always," which creates the need to track separately. By the way, I read the 5yr rule in some places as 5yrs or age 59.5 whichever is second, where others read as whichever comes first. A clarification would be great. – JTP - Apologise to Monica Jun 11 '12 at 19:17
  • @JoeTaxpayer According to Pub 590, p.62, bottom of right column, a Qualified Distribution (meaning no income tax and no penalty) is one that occurs 1. more than 5 years after the first deposit into the Roth IRA and 2, meets one of four criteria a.age at least 59.5, b. disability, c. death of owner, d. "first home" exceptions (as listed on p. 49 of Pub 590) which also includes medical and educational expenses. So it is the later of 5 years and 59.5 years of age, not the earlier (or just 5 years as user102008 claims). See my revised answer too. – Dilip Sarwate Jun 12 '12 at 2:13
  • Once again, Dilip, I tip my hat to you. – JTP - Apologise to Monica Jun 12 '12 at 2:26

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