Roth IRA Conversion Re-Characterization: One “Do-Over” the IRS Allows

image4144Are you having second-thoughts about your Roth IRA Conversion? Did the value of your IRA decrease after you converted it? Are you unable to pay the tax on the conversion? If so, you’re in luck as you can re-characterize your Roth IRA back to a traditional IRA and you can avoid the taxes due too. Given the ups and downs of investments, this may be an excellent strategy for those whose account has decreased since their conversion in 2016.

If you have converted a Traditional IRA to a Roth IRA in 2016, you can reverse the conversion by doing what is called a Roth IRA conversion re-characterization. Under a re-characterization, the Roth IRA funds and assets are rolled back into a Traditional IRA, and the amounts converted are considered contributed to the traditional IRA and you effectively cancel out the amounts converted. As a result of the re-characterization, the taxes that would have been owed for the Roth IRA conversion are no longer due, and the assets and funds re-characterized go back to a Traditional IRA.

A Roth IRA conversion re-characterization is an excellent strategy in two situations. First, if you do not have the funds to pay the taxes on the conversion. Reversing the re-characterization will remove the tax liability. Problem solved. Second, if the investments in your Roth IRA, following the conversion, did not fare so well and if the account decreased in value you are generally better off re-characterizing the conversion and going back to a traditional IRA and then conducting a new Roth IRA conversions at the lower valuation. If you have completed a Roth IRA conversion re-characterization, you do have to wait until the next year to convert the same amounts back to Roth as the IRS restricts you from immediately re-converting after a re-characterization.

Here are a few keys facts to keep in mind for Roth IRA conversion re-characterizations:

1. You must coordinate the re-conversion with your IRA custodian as they will need to roll the Roth IRA funds back to a Traditional IRA. Your tax return also needs to properly report the re-conversion so that you don’t end up paying taxes on the 1099-R you will have received for the Roth IRA conversion.

2. You can re-characterize up to October 15th of the year following the year you converted. So if you conducted a Roth IRA conversion in 2016, you have until October 15, 2017 to re-characterize the conversion. You have until October 15th even if you did not file an extension and even if you have already filed your tax return for the prior year. If you filed a tax return already and claimed the Roth IRA conversion amounts as income, the tax return will need to be amended.

3. Roth 401(k) or other employer in-plan Roth conversions cannot be re-characterized so once those are reported to the IRS you cannot reverse them as the rules applicable to Roth IRA conversion re-characterizations do not apply to 401(k) or other in-plan Roth conversions.

Because of the re-characterization rules, the decision to convert funds to a Roth IRA isn’t as “taxing” as you’d think as you can later have a change of heart if the odds don’t end up in your favor (e.g. lower investment value, or no personal funds to pay taxes on the conversion).

More details and information can be obtained from an informative FAQ page from the IRS here.

By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.


Crowdfunding will soon become one of the most utilized methods of raising capital for small businesses, investment ventures, and start-ups. The concept of Crowdfunding is to loosen the restrictive securities laws so that new or existing companies can raise small sums of money from large groups of people. If you’re unfamiliar with Crowdfunding, check out my prior blog article on the subject here.

Self directed IRA investors will likely be a significant investor group in Crowdfunding offerings as much of the nation’s wealth (and available investment capital) is held in IRAs. Before deciding to invest your IRA into a Crowdfunding offering, self directed IRA investors should consider the following issues and factors.

  1. Will Your IRA Have to Pay UBIT Tax? Many Crowdfunding offerings will generate UBIT tax for the IRA owners of the company. UBIT tax applies to income received by an IRA that is not passive. IRC 511, IRS Publication 598. For example, if my IRA invests into a new tech start-up LLC, then the profits received by the IRA will likely be subject to UBIT tax since the tech company LLC is not a passive business. Also, if my IRA invests into a Crowfuding company that flips real estate the profits my IRA receives will also likely be subject to UBIT tax.Passive income received by an IRA, on the other and, is exempt from UBIT tax. IRC 512. If the Crowdfunding Company is a c-corporation, then there is no UBIT tax as c-corporation dividends to an IRA are exempt from UBIT tax.  Also, rental real estate income, royalty income, and interest income are exempt from UBIT tax.a
  2. An IRA Cannot Buy S-Corporation Shares. An IRA cannot buy stock in an s-corporation as an IRA does not qualify as an s-corporation shareholder. As a result, you cannot use your IRA to invest in an offering of s-corporation shares.
  3. Are You or Your Family Members Involved in the Crowdfunding Company? If you or your family members are owners or part of management in the company raising funds, then it may be a prohibited transaction for your IRA to invest into the Crowdfunding offering. The prohibited transaction rules apply to all IRA investments and essentially create restrictions on investments into companies where the IRA owner or family members of the IRA owner are involved. IRC 4975.
  4. Have Crowdfunding Rules Been Complied With? A Crowdfunding offering must include certain disclosure documents and financial records to prospective investors. Also, the transaction must be conducted through an SEC registered Funding Portal who serves as an escrow/transaction agent for the offering. And lastly, the Crowdfuding rules restrict how much someone may invest from all sources of their funds (personal and IRA). The amount that may be invested annually ranges from $2,000 to $100,000 per person and depends on the IRA owner’s annual income and/or Net Worth. This is an annual collective number for all Crowdfunding offerings and the IRA owner’s personal investments and their IRA investments are combined to reach the maximum limits.
  5. When Do You Need To Take Distributions? Most Crowdfunding offerings will restrict the investors from selling their interest for a certain period of time. Consequently, IRA investors in a Crowdfunding offerings need to plan for the long haul and should not invest into a Crowdfunding offering if they are planning or are required to take distributions from the sums being invested.
  6. Adequate Due Diligence. And last, but certainly not least, have you conducted adequate due diligence on the Crowdfunding offering? Do you understand how the company makes money (or plans to)? What are their operating expenses? What is the experience of the persons running the company? Do you understand the industry the company is in? Do the documents you received match up with what you have been told that peaked your interest in the offering?  I have previously prepared a due diligence top ten list that you can refer to here if you don’t know where to start.

Crowdfunding will become a significant investment option for self directed IRA owners. As a result, self directed IRA owners need to properly analyze the investment options for their IRA prior to executing investments.