The last two blog posts, Three Roth IRA Conversion “Show Stoppers” and Clearing the Roth IRA Conversion Hurdles presented three scenarios in each post where the answer to the question, “Should you convert your traditional IRA’s to Roth IRA’s?” was a definitive “no” and “probably not a good idea,” respectively. Assuming that you weren’t eliminated from the Roth IRA conversion game by any of the three “show stoppers” and you cleared all three “high hurdles,” are you a candidate for a Roth IRA conversion?
Whenever you are evaluating candidates, whether it be for political office, employment, or some other situation, you always want to compare the individual against an established ideal candidate profile. In the case of a Roth IRA conversion, the ideal candidate is someone who will incur minimal or no income tax liability as a result of the conversion.
As emphasized in the last two blog posts, a Roth IRA conversion doesn’t have to be an all-or-nothing event – you can do partial conversions. It’s a rare situation when someone with a traditional IRA with a value of $100,000 or more will be able to convert 100% of it to a Roth IRA in a single year without incurring some income tax liability. It’s much more likely that the stars will align in such a way in a particular year that you will be able to convert a portion of your traditional IRA while incurring minimal or no income tax liability.
There are four situations that come to mind where it’s possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion. All four situations, in addition to assuming availability of a traditional IRA, require preparation of an income tax projection, including calculation of potential exposure to alternative minimum tax, or “AMT,” to determine the amount of the traditional IRA that should be converted to a Roth IRA to achieve this result.
This blog post will discuss the first two situations, with the second two the subject of next week’s post. The first two situations are as follows:
- No current income tax liability without any tax losses
- Sale of rental property with large passive loss carry forward and minimal capital gain and depreciation recapture
No Current Income Tax Liability Without Any Losses
You may be in a situation where your itemized deductions and personal exemptions offsets a large portion of your income, excluding losses, so that you aren’t subject to income tax liability. An example would be a retired individual who is less than 70-1/2 who isn’t receiving any sizeable pensions and is taking distributions from nonretirement investment accounts and/or nonqualified income annuities where a large portion of the payments are nontaxable and who also has enough itemized deductions to offset a large portion of otherwise taxable income. If you are in this situation and you have a traditional IRA, an income tax projection should be prepared to determine the amount of your traditional IRA that you can convert to a Roth IRA while still incurring no income tax liability.
Sale of Rental Property With Large Passive Loss Carry Forward and Minimal Capital Gain and Depreciation Recapture
You may own a rental property with a large passive loss carry forward that hasn’t appreciated much in value that you weren’t thinking about selling anytime in the near future. If you are in this situation and provided that a sale of the property won’t result in a large capital gain and ordinary income resulting from depreciation recapture, the sheltering of all of your income from use of your passive loss carryover resulting from the sale of your rental property may significantly reduce, or even eliminate, your income tax liability in the year of sale. If this is the case, an income tax projection assuming sale of the property should be prepared to determine the amount of your traditional IRA that you can convert to a Roth IRA and not incur more income tax liability than you would have incurred had you not sold the property.
If one of these two scenarios applies to you, have your CPA financial planner prepare an income tax projection for you. If the results show that you will incur minimal or no income tax liability in connection with a partial or full Roth IRA conversion, you may be an ideal candidate for a Roth IRA conversion.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.