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When you file your tax forms, you report contributions to an IRA or Roth IRA. You also report completed conversions (and corresponding tax liability) from one type of account to another. Finally, you can use your tax forms to reverse your conversion by recharacterizing your Roth IRA back to a Traditional IRA.
In 2010, income limits for Roth IRA conversions went away, and thousands of people converted traditional IRAs to Roth IRAs, paying income taxes on investment gains. The rationale for this was that the account holder could pay taxes on gains to-date, but would never have to pay taxes on any additional gains.
For most people, conversion was a great way to avoid long-term tax liability. But in some cases, the conversion may no longer be the best move. You might decide to permanently reverse your conversion, or reverse your conversion and re-convert at a later date (at least 30 days after completing the reversal).
There are many reasons to reverse your conversion. Some include:
To “reverse” your conversion, you actually need to recharacterize your Roth IRA to an IRA. You must do so on your tax return for the year in which you initially converted, meaning your ability to reverse your conversion is time-limited. To complete the recharacterization, follow these steps:
Note that you can also recharacterize IRA contributions made last year as Roth IRA contributions, or vice-versa. We previously wrote about reasons for doing this and the recharacterization process, which is identical to the one outlined above.
For an in-depth discussion of conversion and recharacterization strategies, see “Roth IRA Conversions – An Agressive Strategy”