Sell stock in IRA and then convert to Roth

[Guest Jennif102]

Hi,

I have an IRA right now that's had some good gains right now. I want to sell my positions in order to change up my investments, and I've had 20% in gains on my total portfolio since I bought the positions in July. After that, I want to immediately convert my IRA into a Roth IRA (before the end of this year because I am currently a grad student and therefore in a very low tax bracket for this year only). My question is- since I have held all the investments in my traditional IRA for less than a year- will I have to pay higher Capital Gains taxes on them? Also, is this the right way to do things? Should I convert it to a Roth first then change my investment mix in order to avoid that higher Capital Gains tax? Or am I completely wrong and I won't have to pay capital gains tax at all- I'll just be taxed whatever my tax rate is based on my income? Please help ASAP!!! Thanks!

[Appleby]

Capital gains treatment does not apply to assets held in IRAs.

If you convert your traditional IRA assets to a Roth IRA, you will owe ordinary income tax on the taxable amount of your traditional IRA assets. If your traditional IRA does not include any nondeductible contributions, or rollover of after-tax amounts, then the entire converted amount would be subject to ordinary income tax.

I am not an expert on investment strategies so I can’t say much on that. I do know that you can convert the assets in kind if you wish to. The decision of whether to liquidate the assets is usually determined by whether you think the stocks are still good to hold, or if you think it’s time to get rid of them and choose other investments . You may want to search for post from John G on investments for some help in that area.

[John G]

Yes, you can convert assets in-kind. No, there are not capital gains taxes, no long/short term holding periods inside either IRAs or Roths. You don't need to sell anything to convert. You may or may not want to sell depending upon how you think your holdings will perform. Treat the selling part as a separate decision.

Also, you don't have to convert the entire account. Sometimes a partial conversion makes sense, especially if you are trying to manage the tax impact.

Generally, you want to be able to pay the taxes with money outside of the IRA/Roth. This maximizes the account and keeps you from paying taxes on a distribution.

If a large amount of money is involved, you definitely want to get a profesional (tax advisor or accountant) to make sure you are doing this correctly and your strategy makes sense.

Finally, you have about 4 weeks left to get the conversion done. Custodians get backed up at year end. Get moving pronto if you are doing it this year. Then, monitor your accounts to make sure it gets done before the end of 2007. If you expect to have low income in 07 and 08, you may want to split the conversion into two parts to minimize your tax impact.

Good luck.

[Guest Jennif102]

One more question John G,

I have already started the process and on E*Trade's conversion form, they say they are required by the IRS to offer setting aside 10% of my conversion money for taxes. I have to check a box to say whether or not I want them to do this and designate how much. I know I'll pay a penalty on this money because it is a distribution- but it's a relatively small amount of money ($2000 or so) and I think it's probably best to pull it out now in case I don't have that money to pay for my taxes in April. Is this a really bad move??

Thanks!

[John G]

If you don't have the outside funds to pay the taxes, then perhaps you should not convert, or perhaps do a partial conversion. The advantage of a conversion degrades when you are taking out funds out of the IRA (shrinking the asset base), paying a 10% penalty and paying taxes. That seems like 3 strikes against it, does it not?