Is recharacterization of an IRA contribution potentially a taxable event?

Question

I contributed $5500 to a new Traditional IRA earlier this year. Since I did not have a 401(k) at work, it would have been deductible. However, now I am getting a 401(k), and my income is over the deductibility limit. I am still under the Roth contribution income limits though, so I can recharacterize. If the Traditional IRA has since grown to $6000, is the $500 gain taxable as income when I recharacterize?

NOTE: I know conversion is an option too (treating the initial contribution as non-deductible Traditional IRA), but in that case I know I'd be taxed on the $500 gain, plus I have another, much larger Traditional IRA with all pre-tax money, so nearly all of my conversion would be taxable.

Answer 1

No, it is not a taxable event. You will not have to pay tax on the $500 in this scenario. See the IRS publication 590-A:

To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the tax year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following.

• Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount.

• Report the recharacterization on your tax return for the year during which the contribution was made.

• Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.