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Tracking basis in IRAs - when is it important?
Old 01-25-2009, 12:34 PM   #1
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Tracking basis in IRAs - when is it important?

In which of the examples below is it important to track your investment basis in your IRA accounts?

1) Roth IRA

2) Traditional IRA (deductible)

3) Traditional IRA (non-deductible)

4) Rollover IRA (i.e. money you had invested in a 401K plan and then rolled into a separate rollover IRA)

5) SEP-IRA

6) Others?

And for those accounts where it is important to track your basis, when do you need to have that information? And what's the consequence if you don't have that information available when you need it?

I'm a little confused by this and figured that some experienced hands on this board have already figured this out. Thanks!
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Old 01-25-2009, 12:39 PM   #2
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#3, #4. You will need this information to calculate taxes on future distributions. During accumulation phase, you'll get info on this from your IRA custodian. In any year when you make a non-deductible IRA contribution you need to file a form 8606 with your 1040.

#6: You always need to know the basis of investments in a taxable account to determine capital gains/losses in the year you sell. Again, this would come from your records and the reports provided by your broker.

You can get a lot of information about this type of record-keeping at Fairmark Press Tax Guide for Investors.

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Old 01-25-2009, 02:05 PM   #3
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Check out the Purpose/Who must file sections on the first page of the instructions for Form 8606.
http://www.irs.gov/pub/irs-pdf/i8606.pdf

You also need to track basis when doing distributions and Roth conversions.
In principle, IRS can fine you for not filing Form 8606 although my understanding is that they have been pretty lenient so far. The worst part would be that if you couldn't prove basis, they might make you assume 0 basis and you would be effectively be taxed twice on that part.
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Old 01-25-2009, 09:16 PM   #4
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#1

Withdrawals from a Roth IRA are considered to be taken out in this order:
1) contributions (already taxed)
2) conversions (already taxed)
3) earnings (not taxed)

You can take out contributions at any time without tax implications...a Roth IRA can function as an emergency savings account for some because of this. When you withdraw enough to get into the third bucket (earnings), you may have to consider it taxable income and possibly pay a 10% penalty in certain circumstances.

If the Roth IRA has been established for at least 5 years, earnings will be non-taxable when withdrawn if the Roth owner is 59 1/2, dead, disabled, or buying their first home.

So knowing your basis in the Roth IRA will keep you straight on what's coming from 1) or 2) vs the earnings in 3) that may be taxable and also draw a penalty if you don't meet one of the qualifying criteria.
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Old 01-25-2009, 09:59 PM   #5
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Quote:
Originally Posted by Gotadimple View Post
#3, #4. You will need this information to calculate taxes on future distributions.
I don't understand. Why would you need to know basis for a rollover IRA (#4)? It will all come out as taxable ordinary income, just as with a "normal" deductible IRA. Am I missing something?
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Old 01-25-2009, 10:07 PM   #6
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Got me. I think it's a distinction without a difference.

Years ago, the tax gurus would recommend keeping "contributory" IRAs separate from "rollover" IRAs. I don't think that is the case anymore. When I left my Megacorp job, I rolled my 401k right into my traditional IRA so it's comingled now. Like you said, it's all taxable when it comes out (since it's never been taxed before, assuming all the contributions were deductible).
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Old 01-25-2009, 10:13 PM   #7
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Originally Posted by Gardnr View Post
I don't understand. Why would you need to know basis for a rollover IRA (#4)? It will all come out as taxable ordinary income, just as with a "normal" deductible IRA. Am I missing something?
When my FIL retired from CBS, he rolled his 401(k) over to a conventional IRA. Some of the 401(k) contributions were from his before-tax dollars and some were from his after-tax dollars. That basis had to be transferred to his IRA so that he could accurately convert it over to a Roth.

Or else the basis had to be tracked because the IRS says so and expects a Form 8606 or a $50 fine...
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Old 01-25-2009, 10:56 PM   #8
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A decade or 2 ago I made a few non-deductible IRA contributions, and had to file 8606's each year to document my total non-deductible contribution. Now that I am taking 72t distributions, I file 8606's each to to document the decrease in my remaining non-deductible total - my 2008 distribution had about a $120 basis, using up that much of those contributions.
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Old 01-26-2009, 10:14 AM   #9
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Originally Posted by Gardnr View Post
I don't understand. Why would you need to know basis for a rollover IRA (#4)? It will all come out as taxable ordinary income, just as with a "normal" deductible IRA. Am I missing something?
If you made any non-deductible contributions to that IRA, they *won't* be taxed upon withdraw (they were already taxed). So, they need to know.

When I rolled over my 401K to an IRA, for some reason I had a small $ amount of non-deductible contributions. The broker would only accept the deductible portion, probably so they don't need to bother with the accounting. Fine by me, I just took them in cash, no further concerns with that account.

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Old 01-26-2009, 10:53 AM   #10
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If you live in Pennsylvania and ever wish to take an early withdrawal from a retirement account, you'll need to know the PA state basis. PA does not provide any tax deduction for retirement savings in 401k's or IRAs. So if you take an early distribution, the state income tax is figured on a cost recovery method. The distribution is not taxable until it exceeds your state basis.

And almost no one know there basis when I ask when completing their state tax return.

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Old 01-26-2009, 09:55 PM   #11
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Quote:
Originally Posted by Nords View Post
When my FIL retired from CBS, he rolled his 401(k) over to a conventional IRA. Some of the 401(k) contributions were from his before-tax dollars and some were from his after-tax dollars. That basis had to be transferred to his IRA so that he could accurately convert it over to a Roth.

Or else the basis had to be tracked because the IRS says so and expects a Form 8606 or a $50 fine...
Re: yours and ERD50's replies

I now see the reason given the after-tax contribution considerations. I've just never run into that situation; didn't know it existed!

You learn something everyday (well, most days).

With that said, the original reply stating that tracking basis for a rollover is necessary/required should include a stipulation for this case. Most people won't be in that situation and thus don't need to worry about it. I know I don't!
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Old 01-26-2009, 10:40 PM   #12
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Also I would track cost basis on even Roth IRAs. Who knows what our friends the gummint will decide later. Like, we'll grandfather in all gains made through 2010 () but then we'll tax the rest at 10%, or something like that. And, oh yeah, if you can't prove your basis we'll just have to confiscate it all as possible drug money.
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