Why and How to Recharacterize an IRA Contribution
By Kristiana Rodriguez
A recharacterization is a transaction that allows an IRA owner to “undo” a regular Traditional or Roth IRA contribution and to treat it as though it had been made to the opposite type of IRA. Current year contributions—plus the net income attributable (NIA) to the contribution—are eligible to be recharacterized. An IRA owner may still recharacterize 2023 contributions (up to $6,500, or $7,500 if eligible for a catch-up contribution). All eligibility requirements for contributions to the alternate type of IRA apply. The deadline to recharacterize 2023 contributions is October 15, 2024, assuming that the IRA owner filed her taxes timely (with or without an extension).
Common Reasons for a Recharacterization
An IRA owner discovers that his Traditional IRA contributions are not deductible because of his income and his—or his spouse’s—participation in an employer-sponsored retirement plan.
An IRA owner learns that her modified adjusted gross income (MAGI) is too high to be eligible to contribute to a Roth IRA.
A deemed excess contribution—an eligible, but unwanted contribution—may be recharacterized to a different type of IRA.
While current year contributions, with NIA, can be recharacterized, the following contributions are ineligible for recharacterization.
SEP and SIMPLE IRA plan contributions
Conversions to Roth IRAs
Rollovers or transfers between two like IRAs
Rollovers from employer-sponsored retirement plans to IRAs
Note: Before 2018, Traditional, SEP, and SIMPLE IRA conversions to Roth IRAs, and retirement plan-to-Roth IRA rollovers of non-Roth amounts, were eligible for recharacterization. The Tax Cuts and Jobs Act of 2017 eliminated that option.
Processing a Recharacterization
The recharacterization must be processed through a direct transfer of funds between financial organizations if it is not done entirely within one organization: the IRA owner should not receive the funds. This transaction must be completed by the above-described deadline.
The IRA owner may recharacterize all or part of the contribution, plus the NIA associated with that full or partial amount. It should be noted that the NIA may be negative if there is an overall loss in the IRA’s value during the period between the contribution and recharacterization. In such cases, less than the principal contribution amount is transferred to the alternate type of IRA. The tax year of the contribution is not changed by a recharacterization. After the transaction is completed, it cannot be undone.
An IRA owner must make an irrevocable election to recharacterize a contribution. The election to recharacterize a contribution is made when the IRA owner notifies the financial organizations involved that he is electing to treat the contribution made to the first IRA as if it had been made to the other type of IRA. Many financial organizations obtain this election using a recharacterization request or an IRA contribution form. The election notification must include
the contribution type (Roth IRA or Traditional IRA) and dollar amount that is being recharacterized,
the date on which the contribution was made to the original IRA,
the year for which the contribution was made,
instructions to the financial organization holding the distributing IRA to move funds directly to the receiving IRA (if not internal),
the names of the organizations—if different—holding the two IRAs, and
any additional information needed to complete the recharacterization.
Reporting a Recharacterization
A recharacterization is a reportable transaction, even though it is processed through a trustee-to-trustee transfer or entirely within one organization.
Form 1099-R
Prior-year and same-year recharacterizations are reported differently, using different codes in Box 7 on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. If the same account owner has both prior-year recharacterizations and current-year recharacterizations, they will be reported on separate Forms 1099-R. Unlike the correction of IRA excess contributions, the year for which a contribution was made determines whether it will be a prior-year or current year recharacterization. For example, a contribution made in 2024 but for 2023 and recharacterized in 2024 is a prior-year recharacterization. A contribution that is both made for 2024 and recharacterized in 2024 is a current-year recharacterization.
Box 1, Gross distribution – Enter the recharacterized amount plus the NIA.
Box 2a, Taxable amount – enter 0 (zero).
Box 2b, Taxable amount not determined – do not mark,
Total distribution checkbox - mark if the distribution depletes the IRA.
Box 7, Distribution code – Use code N or R.
Code N is used to report the recharacterization of an IRA contribution made for 2024 and recharacterized in 2024.
Code R is used to report the recharacterization of an IRA contribution made for 2023 and recharacterized in 2024.
NOTE: Until the October 15, 2024, deadline, use code R to report recharacterizations of IRA contributions made for 2023. Use code N to report any contributions that are made in 2024 and recharacterized in 2024.
Form 5498
Unlike Form 1099-R reporting, there is no split reporting on Form 5498 for multiple recharacterizations that were made in the same year but apply to different contribution years. Any IRA contributions recharacterized in the same year are reported on one Form 5498, IRA Contribution Information. The IRA’s fair market value and any IRA contributions not recharacterized may be reported on the same Form 5498, but it is not required. Such other amounts can be reported on a separate Form 5498, at the custodian’s discretion.
Box 4, Recharacterized contributions – Enter the recharacterized amount plus the NIA (or a reduced amount, if the NIA is negative).
Box 5, FMV of account – Enter the IRA’s fair market value.
Box 7, Check the appropriate type of IRA.
