IRA re-characterization after capital gains

[MeatHead]

Our AGI is between 98K and 118K, so I can do a partial deduction for my tIRA.  In real life, I just wait until I do my taxes, calculate how much I can contribute, and then put that much in.  However, that's too easy and doesn't scratch the itch for learning about tax laws.

So suppose I just put the full 5500 in there and then plan to recharacterize when taxes roll around (let's assume I can deduct half).  If my 2017 contribution of $5500 is made in April, 2017, and I put it into some fund that returns 10% by April, 2018, how are those gains figured into my recharacterization? 

For instance, do I just pay income taxes on half of the gains and then move ($2250+$112.50-$taxes) to the Roth?  Is the recharacterization a taxable event?  That is, do I have to pay capital gains taxes on it in addition to income tax?

Does the amount of cash I have laying around in the IRA affect this?  If I have 5500 cash, can I pretend that my new contribution went to the money market fund and that the old cash from last year bought the fund?

I actually did read through pub 590A before asking this but couldn't find anything about gains, although that's no guarantee that the answer isn't in there...

[tralfamadorian]

I just had to do a partial recharacterization yesterday.  You have your plan provider move the requested amount from one IRA to the other plus any gain or loss it has made during that time period.  If you held in stocks, then the stock gain or loss.  If you held in cash, then there is no gain/loss.  If you held in money market, then the modest money market interest gained.

For example, if you plan to recharacterize $2,750 that you contributed in April that has had a 10% return, then you have your provider move $3,025 from your tIRA to your rIRA.  You must have your provider move the funds- if you do so, it is a withdrawal (taxable event with 10% penalty).  If moved by your provider you end up paying taxes on the $2,750 at your marginal rate through your 2017 taxes because it is no longer a deduction on your 1040.  My provider calculates the gain/loss automatically and asks if I have a preference on which funds I would like moved (particular stock, cash, mixture) so I can control somewhat how much gain/loss is moved depending on the diversification of the funds in the IRA. 

[MeatHead]

Excellent, thanks for the clarification.  Also, dividing by 2 is hard.

That's handy that you don't have to sell your position to have it moved; seems like only cash/mm can go in, so I figured it was the same on the way out.

I wonder if this could be used as a way to get losing positions out of your IRA and deducted from income tax.  That is, if I bought $2750 of MEAT stock in the IRA two years ago, but MEAT is down by 10%, can I pick that to move over this year (instead of my newly purchased successful HEAD stock, up 10%) and then only pay taxes on 2475? 

[tralfamadorian]

That's handy that you don't have to sell your position to have it moved; seems like only cash/mm can go in, so I figured it was the same on the way out.

I'm not positive that this would be true of all providers but it's true for my tdameritrade tIRA to tdameritrade rIRA.

I wonder if this could be used as a way to get losing positions out of your IRA and deducted from income tax.  That is, if I bought $2750 of MEAT stock in the IRA two years ago, but MEAT is down by 10%, can I pick that to move over this year (instead of my newly purchased successful HEAD stock, up 10%) and then only pay taxes on 2475?

The gain/loss is from only the time in which the IRA held the stock.  So that MEAT is down 10% in two years is immaterial; how much it is down during the time period from the contribution to the recharacterization is.  But unfortunately the tax code doesn't allow for you to benefit from that change in the current tax year:

Contribution April 1, 2016: $5500.
Purchased $2750 MEAT April 2, 2016
Purchased $2750 HEAD April 2, 2016
March 27, 2017: MEAT $2475
March 27, 2017: HEAD $3025

Scenario #1:
Recharacterize $2750 of initial April 2, 2016 contribution to rIRA.  Provider moves $2475 MEAT to rIRA ($2750 initial - $275 loss).  Deduct $2750 on 1040 for remaining $2750 tIRA contribution.

Scenario #2:
Recharacterize $2750 of initial April 2, 2016 contribution to rIRA.  Provider moves $3025 HEAD to rIRA ($2750 initial + $275 gain).  Deduct $2750 on 1040 for remaining $2750 tIRA contribution.

[MeatHead]

Ah, I understand now--the gain or loss is treated as if the money were in the Roth the whole time, and in neither case does the amount deducted need to change.

Thanks much for the input.  Of course, it all seems pretty obvious now that you spell it out for me!