Clarifying RMDs and Cost Basis in IRAs
If you are an investor with an Individual Retirement Account (IRA), the process of using Required Minimum Distributions (RMDs) can sometimes be a source of confusion. Specifically, if an RMD is used out of an IRA by transferring stock out and paying income taxes on the total value of the stock, how does this impact the cost basis? Let's break down the process and clarify some common misconceptions.
Why Would You Do That Silly?
The process of using an RMD from an IRA is often misunderstood. When an RMD is taken from an IRA, it usually involves the IRA liquidating the securities and converting them into cash. This means you would receive a check, not shares of stock that you can hold outside of the IRA.
Here's why you wouldn't directly sell the stock outside of the IRA to pay taxes:
The transaction occurs within the IRA structure, meaning the IRA itself is responsible for withholding taxes and recording any basis in the shares.
The recipient of the RMD (which is the IRA account holder) would not be aware of the specific securities sold, making it impossible to track the basis or tax paid.
Therefore, you can't take RMD-adjusted shares out of an IRA and use them to pay taxes elsewhere. The IRS and the IRA's custodian handle all the tax implications and any required basis tracking internally.
How Does an RMD Work with Withdrawals?
When you take a distribution/withdrawal (or RMD, if applicable) from an IRA, the securities are liquidated and sold for cash. You then receive a check, not shares of stock to hold outside the IRA. The withdrawal is treated as ordinary income for tax purposes and does not have a capital gain component.
A Form 1099R is issued to show the amount of cash distributed. You have the option to withhold from the distribution or pay any tax due when you file your return the following year.
Clarifying Cost Basis in RMD Situations
A common question is whether the cost basis changes when you transfer stock out of an IRA as part of an RMD and pay income taxes. Let's dispel this myth:
If you use an RMD to transfer stock out of an IRA and then pay income taxes on the total value of the stock when you sell those shares later, the cost basis is not the stock price multiplied by the number of shares plus the income tax paid. Instead, the cost basis is the share price on the day the stock was transferred from the IRA.
It's important to understand that the IRS presumes the amount recognized as an RMD is the cost basis for the stock. This is a straightforward but often misunderstood aspect of IRA accounting.
For further clarity, here's a summary of the key points:
RMDs are taken from the IRA, not by directly selling stocks outside the IRA.
Securities are converted to cash, and you receive a check.
The cost basis is the share price on the day the transfer occurs, not the sum of the transfer value plus taxes paid later.
Understanding these concepts is crucial for proper tax planning and accounting in IRA distributions.