So, you converted a traditional IRA to a Roth IRA in tax year 2001, paid tax on the converted amount, and your Roth tanked.  Help is available-if you hurry.  You have until October 15, 2002 to "unconvert" or recharacterize all or part of the Roth IRA conversion you made during calendar year 2001.  The recharacterization will return you to a tax position as if you had never made the Roth IRA conversion.  You will have a lower balance in your IRA (remember your investment tanked.), but at least you will get a refund for the taxes on the conversion.

If you:

• filed your 2001 return by April 15, 2002 (the standard due date), or
• received the first extension and filed by August 15, 2002 (the deadline for the first extension), or
• even filed a second extension and subsequently filed a return showing the Roth IRA conversion, then
• you will have to file an amended return on Form 1040X (available from the IRS website, http://www.irs.gov/) by October 15, 2002 to take advantage of the opportunity to recharacterize your Roth.  Attach a statement to the amended return explaining that you recharacterized your 2001 Roth conversion. In addition, we recommend that you file your amended return, Form 1040X, with the words "Filed Pursuant to Section 301.9100-2" written along the top margin of Form 1040X.

Whether filing the amended return is worth the aggravation and expense depends on the amount of the conversion and the amount the investment dropped.  I would probably want to see at least a $1,000 drop before the amended return becomes worthwhile.

If an accountant or CPA prepares your tax return, review with them whether it pays to recharacterize.  To give you some type of price guideline, our CPA firm would charge about $125 to prepare an amended return if we had prepared the original return.  It would be closer to a $200 job or more if we had not prepared the original return.

If you have properly applied for the October 15, 2002 extension to file your 2001 return, then you will not show a tax liability for the amount converted and recharacterized but must file by October 15, 2002.  Also, attach a statement to the return explaining the recharacterization.

If you prepare your own taxes, and you have applied for the October 15, 2002 extension for filing your 2001 return and have not yet filed the return,

• and you are planning to unconvert the entire amount of the Roth IRA, you will report the traditional IRA distribution on Line 15a of your Form 1040 return and attach a statement to the return explaining that none of the distribution is taxable because you recharacterized the Roth IRA conversion.
• and you are planning on unconverting only a part of the amount you initially converted, you report the amount not unconverted on Form 8606―also available from http://www.irs.gov/.

In either case, we recommend that you attach a statement to your return explaining the recharacterization.

How to Recharacterize

Before you file your amended return, you must notify the Trustees (the financial institutions holding your IRA―for both the IRA and the Roth IRA) on or before the transfer date that you want to "unconvert" or recharacterize a particular Roth IRA.  The notification must contain the following information: 

• the type and amount of the contribution to the Roth IRA to be recharacterized;
• the date on which the contribution was made and the tax year for which it was made;
• a direction to the Trustee to transfer, in a trustee-to-trustee transfer, the amount of the contribution and any net income allocable to it to the Trustee of the recipient IRA;
• and any additional information needed to make the transfer. [i]  

If both of your IRAs are maintained by the same Trustee, simply redesignating the IRA will be treated as a trustee-to-trustee transfer. [ii]

This strategy was the subject of a peer-reviewed article designated as Editor's Choice in the September-October 2002 issue of the Journal of Retirement Planning, published by CCH Incorporated.