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IRA-to-IRA Rollover Pitfalls and How to Avoid Them

Back to Fall Tax Planning Guide Index * Traditional Individual Retirement Accounts * Back to Adjustments to Income * Roth IRAs

Direct, trustee-to-trustee transfer from one IRA to another IRA is a relatively uncomplicated transaction. A properly completed direct transfer is not subject to income tax, is not reported on the taxpayer's return, and is not subject to the once-a-year limit that applies to IRA rollovers. For a variety of reasons, however, a taxpayer may prefer to use a regular rollover, one that involves taking assets out of an IRA and then redepositing them to an IRA within 60 days.

Note: The tax law only allows one rollover per IRA within a 12 month period but a taxpayer can have as many trustee-to-trustee transfers within a year as needed. The once a year rule does not apply to rollovers of pension distributions. [Letter Ruling 8651085]

The IRA rules contain many pitfalls that can ruin a rollover if the taxpayer is not careful. The following are typical rollover traps and how to avoid them:

1. If you take a cash distribution, to purchase investments (stocks, etc.) and then transfer those new investments into the rollover IRA, you could be hit with income taxes on the rollover. The law requires that the rollover contribution must be in the same form as the distribution, i.e., cash for cash or investment for investment. Even if the 60-day time limit is met for the tax-free rollover, this distribution will be subject to the 10% early withdrawal penalty if the taxpayer is not 59 years of age. (Lemishaw v. Commissioner 110TCNO. 11 (1998).

2. Missing the 60-day limit: For a rollover to be tax-free, the amount distributed from the IRA must be recontributed to an IRA no later than 60 days after the date that the taxpayer received the withdrawal from the IRA or pension. Code Sec. 408(d)(3)(a). IRS has on many occasions ruled privately that the 60-day rollover period cannot be waived even if the taxpayer was not at fault for missing it. In fact, IRS said that the 60-day statutory deadline for rollovers could not be changed administratively, even when filing deadlines were postponed because of hurricanes. (Notice 92-40)

In a case involving IRA funds withdrawn by a taxpayer that were subject to a court order pending divorce proceedings one court has held that even judicial constraints imposed on funds withdrawn from an IRA does not excuse or extend the 60-day period for rolling them over. The court rejected the position that the 60-day period did not begin to run until the constraints were lifted, after 18 months. (Rini, Gusty v. Comm (1992, CA6)

3. The tax-free rollover break works only if the taxpayer timely recontributes to his own IRA. Thus, the transfer by a taxpayer of a portion of his IRA to his spouse's IRA was a distribution included in the taxpayer's gross income under Code Sec. 408(d)(1). IRS ruled privately that the provision taxing distributions from an IRA was not overridden by Code Sec. 1041(a), which provides that no gain or loss is recognized on the transfer of property between spouses. (IRS Letter Ruling 9422060; IRS Letter Ruling 8820086).

4. A tax-free rollover from an IRA into another IRA may be made only once a year. The one-year waiting period begins on the date the taxpayer received the IRA distributions, not on the date when he rolls it over into another IRA. (Code Sec. 408(d)(3)(B)).

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