Dear Tax Talk,
I have $5,000 in Schedule E losses on my 1040 and no other income. To offset this tax loss, in December 2008 I converted $6,000 from my traditional IRA to my Roth IRA.
Now I'd like to recharacterize $1,000 back to my traditional IRA (essentially making the $5,000 net transfer tax-free). Is this logic correct? Also, if my Schedule E losses are thereafter adjusted to $4,900, can I do a second recharacterization (for $100)? Is there any limit to the number of recharacterizations for any tax year (so long as the total is less than or equal to the amount originally converted)?
Also, does the recharacterization have any implications for me if I have Schedule E losses in the 2009 tax year that I want to offset with a further conversion from a traditional to a Roth IRA?
-- Albert
Dear Albert,
A Schedule E loss usually arises from a rental activity or as a pass-through from a partnership or S corporation. Converting a traditional IRA into a Roth IRA results in the recognition of income to the extent of the conversion.
When an individual has excess deductions for the year, a good tax strategy would be to convert a similar amount from a traditional IRA to a Roth IRA, as it does not result in any tax. Subsequent withdrawals from a Roth IRA are tax-free even if the taxpayer does not have excess deductions.
When you look at your excess deductions, you shouldn't just look at your Schedule E losses. You're also entitled to claim standard or itemized deductions and personal exemptions. In 2008, the standard deduction for a single person and the exemption would have offset another $9,000 in converted IRA funds.
If you overestimate the funds to be converted, you can recharacterize the excess in any amount as many times as necessary to get the desired result. Of course, you can only recharacterize up to the original conversion. Any additional recharacterization would be the equivalent of making a deductible IRA contribution and, hence, not considered a recharacterization.
The recharacterization has to be done by the due date, including extensions, of your return. The recharacterization of a prior year conversion does not affect your ability to convert funds during the current tax year.
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