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I contributed $5,500 to my Roth IRA in this year. Later on I realized I might not be eligible for a Roth IRA contribution so I recharacterized that contribution as a traditional IRA. The market had gone down in the meantime and my custodian deposited $4,900 to my traditional IRA. Now I have converted that money back into a Roth IRA and net present value has changed to $5,100 at time of conversion. How do I file my tax return (specifically form 8606)?

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I wrote an article about this a while ago with detailed instructions, so I'll link to it here.

Here's a snippet about how to use the Roth IRA loophole and report it properly:

  1. You don’t have any Traditional/Rollover IRA at all.

  2. You deposit up to the yearly maximum (currently $5500) into a traditional IRA. In your case, you re-characterized, which means you essentially deposited. The fact that it lost money may help you later if you have extra amounts in Traditional IRA.

  3. You convert your traditional IRA to become Roth IRA ($5500 change designation from Traditional IRA to Roth IRA).

  4. You fill IRS form 8606 and attach it to your yearly tax return, no tax due. You have a fully funded Roth IRA account.

If you have amounts in the Traditional IRA in excess to what you contributed last year - it becomes a bit more complicated and you need to prorate. See my article for a detailed example.

On the form 8606 you fill the numbers as they are. You deposited to IRA 5500, you converted 5100, your $400 loss is lost (unless you have more money in IRA from elsewhere). If you completely distribute your IRA, you can deduct the $400 on your Schedule A, if you itemize.

  • The second sentence in point 2 seems incomplete. Can you finish it? "... you essentially deposited ..." – dg99 Dec 11 '15 at 16:56
  • @dg99: Re-characterization means that, for tax purposes, you "pretend" as if it was done a different way to begin with. Here you re-characterized from a Roth IRA contribution to a Traditional IRA contribution. So for tax purposes, you report everything as if you originally contributed to a Traditional IRA on the original date you contributed, and never contributed to a Roth IRA. – user102008 Dec 13 '15 at 19:00

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