How to Convert Depreciated Stock to a Roth IRA

You can transfer stock, depreciated or not, that you hold in a traditional individual retirement arrangement or qualified retirement account into a Roth IRA, but the Internal Revenue Service does not permit you to make the same kind of transfer with stock currently residing in a nonqualified account -- such as an executive bonus plan. To make an eligible transfer, all that's needed is a little paperwork.

Roth IRA

If you don’t have one yet, you’ll need to set up a Roth IRA. If the depreciated stock resides in a traditional IRA or qualified account at a custodian that also offers Roth accounts, you can simply have the custodian change the account type if you are converting the entire account. Otherwise, you can set up a Roth IRA with the current or new custodian and begin the transfer process. Your current custodian will have you fill out transfer forms on which you specify a full or partial Roth conversion.

Transfer-in-Kind

The key to a successful conversion of stock to a Roth IRA is to specify a “transfer-in-kind” on the transfer forms. This alerts the current and new custodians to move the shares as-is rather than selling them for cash. If you are making the transfer before April 15, indicate which tax year to use for the conversion: the previous year or the current one. The 60-day time limit on rollovers does not apply to trustee-to-trustee transfers.

Taxable Income

When you convert a qualified account to a Roth IRA, you create taxable income in the conversion year. The income is taxable at your marginal rate. The taxable amount is the current value of the assets transferred, excluding any nondeductible contributions. The IRS has you value the conversion equal to the amount of taxable income you would create had you simply withdrawn the proceeds rather than converting them into a Roth IRA. The amount of taxable income you create by converting depreciated stock is its current market value, not the purchase cost. Otherwise, there would be two different values for taxable income depending on whether you withdraw the shares directly or sell them first.

Tax Forms

If the assets for your Roth conversion, including the depreciated stock, come from an account that never had nondeductible contributions, indicate the taxable income resulting from the conversion on Form 1040 or one of its variants. Use Form 8606 if the source account contains nondeductible contributions; these do not create taxable income. If you are making a partial conversion, Form 8606 will help you prorate the untaxed conversion amount. If you make any of your nondeductible contributions during the tax year, also use Worksheet 1-5 in IRS Publication 590.

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