To calculate your Roth IRA basis of conversions, take your cumulative nondeductible Traditional IRA contributions, divide that figure by the December 31 fair market value of every Traditional, SEP, and SIMPLE IRA you own (with the amount you converted added back in), and multiply the result by the amount you converted. That product is your basis recovered in the conversion, the portion you don’t owe income tax on. The rest is ordinary income. The rule sits in Internal Revenue Code Section 408(d)(2), and the reporting happens on Form 8606.
The mechanics look simple on paper. Where people go wrong is in what belongs in each part of the fraction, and in tracking the basis figure over time so it’s actually available when they need it.
What Basis Is
Basis is the running total of money you put into Traditional IRAs that never got you a tax deduction. The most common source is nondeductible Traditional IRA contributions, usually made because your income was too high to qualify for the deduction. Once those after-tax dollars go in, they become basis, and tracking them is what keeps you from being taxed on the same money twice when you later withdraw or convert.
Your basis grows every year you make a nondeductible contribution and shrinks only when you pull some of it out through a distribution or conversion. You report the running total on Form 8606, Part I, for every year you make a nondeductible contribution. Skip a year and there’s a $50 penalty, but the bigger problem is that the IRS has no official record those contributions were after-tax. Keep every Form 8606 you file. Those forms are your proof of basis in an audit.
What Gets Aggregated
You don’t get to pick which IRA dollars you’re converting. Under Section 408(d)(2), all of your non-Roth IRAs are treated as a single account for purposes of calculating the taxable portion of a distribution or conversion. Every Traditional IRA, SEP IRA, and SIMPLE IRA you hold gets combined, no matter how many custodians are involved.
A few balances stay out of the pile. Roth IRAs are in their own category and don’t enter the calculation. Inherited IRAs from someone else are excluded, unless you’ve elected to treat one as your own. Employer plans like 401(k)s, 403(b)s, and 457(b)s are not part of IRA aggregation and have their own rules.
Spouses calculate independently. Your spouse’s IRA balances don’t get added to yours. If you both have Traditional IRAs, each of you runs the formula on your own accounts.
Running the Pro-Rata Calculation
The pro-rata rule stops you from cherry-picking only the basis out of your IRAs and leaving the pre-tax money behind. Every dollar that leaves your aggregated IRA pool carries a proportional mix of basis and taxable money. The steps:
- Add up the December 31 fair market value of every Traditional, SEP, and SIMPLE IRA you own for the year of the conversion. This date is fixed by statute even if you converted months earlier.
- Pull your total unrecovered basis from your Form 8606 records: cumulative nondeductible contributions, minus any basis already recovered through prior distributions or conversions.
- Divide your basis by the total year-end value of all non-Roth IRAs after adding back the conversion amount (the statute increases the denominator by distributions made during the year). That’s the non-taxable ratio.
- Multiply the non-taxable ratio by the amount you converted. The product is your tax-free basis recovery. The remainder is taxable at ordinary income rates.
A worked example. You convert $20,000 to a Roth IRA. On December 31, the combined value of all your non-Roth IRAs, with the conversion added back, is $100,000. Your cumulative nondeductible contributions total $30,000. The non-taxable ratio is $30,000 ÷ $100,000, or 30%. So $6,000 of the conversion is tax-free basis recovery and $14,000 is taxable. Your remaining basis drops from $30,000 to $24,000, and that new figure carries forward.
Why the December 31 Snapshot Can Break Your Math
The year-end valuation catches people off guard. Convert in March when your Traditional IRA balance is small, then roll a large 401(k) into a Traditional IRA in November, and that rollover shows up in your December 31 total. It dilutes your non-taxable ratio and turns what looked like a mostly tax-free conversion into a mostly taxable one. The December 31 snapshot governs the whole calculation regardless of when in the year you actually converted.
Reporting It on Form 8606
You report the calculation on Form 8606, filed with your Form 1040. Part I tracks cumulative basis: you enter the carryover from your last Form 8606, add any new nondeductible contributions for the year, and arrive at total basis before the conversion. Part II handles the conversion itself. It asks for the aggregate December 31 fair market value of all your non-Roth IRAs and the total amount converted, then walks the pro-rata formula to split the conversion into taxable and non-taxable pieces.
Line 14 carries your remaining basis forward. It subtracts the basis you recovered this year from your prior total, and that Line 14 figure becomes the starting point on next year’s Form 8606. The taxable portion flows to your Form 1040 as ordinary income.
File Form 8606 in any year you make a nondeductible contribution, take a distribution from an IRA that contains basis, or convert any amount to a Roth. Even if the whole conversion is covered by basis and you owe zero additional tax, the form is still required.
Your custodian’s Form 1099-R usually won’t do the taxable-amount work for you. The custodian typically checks the “Taxable amount not determined” box because they have no visibility into your basis across all accounts. Calculating and reporting it is on you.
If You Never Filed Form 8606 for Past Contributions
Nondeductible contributions from prior years still count as basis even if you never filed the form. The problem is proving it. Without filed 8606s, the IRS has no record of your after-tax money, and a conversion could be treated as fully taxable.
You can file Form 8606 for prior years to establish the missing basis. The IRS generally accepts standalone Form 8606 filings for past years without requiring a full amended return (Form 1040-X), because the form is informational and doesn’t change your tax liability for those years. If you already filed a Form 8606 that turned out to be wrong, file an amended return with the corrected form attached.
Gather what you can: old tax returns, brokerage statements showing contributions, bank records showing transfers. Rebuild your contribution history year by year, then prepare a Form 8606 for each year a nondeductible contribution was made. It’s tedious. It’s much easier than discovering the gap in the middle of a conversion.
How Your Basis Figure Follows You Into the Roth
Once converted money is in the Roth, distributions come out in a fixed statutory order: regular Roth contributions first, then converted amounts (oldest conversions first), then earnings. Within each conversion, the taxable portion comes out before the basis portion.
Two five-year clocks apply, and they’re easy to confuse. The first starts on January 1 of the tax year you make your first-ever Roth contribution or conversion. Once five tax years have passed and you’ve reached 59½, all withdrawals are qualified: earnings come out tax-free and penalty-free. This clock starts once and covers every Roth IRA you own.
The second clock applies to each individual conversion and only matters for the 10% early withdrawal penalty under Section 72(t). Each conversion starts its own five-year period. If you’re under 59½ and withdraw the taxable portion of a conversion before its five years are up, the 10% penalty may apply. The statute limits that penalty to “the amount of the qualified rollover contribution includible in gross income,” so the basis portion of the conversion is not subject to the penalty. It was already taxed when you originally contributed it, and you can pull it out of the Roth without penalty regardless of your age or how recently the conversion happened.
This is where the basis number you calculated does its second job. It tells you exactly how much of each conversion sits outside the five-year penalty window and how much is inside it. The taxable slice of a recent conversion may still avoid the penalty if you qualify for a standard early-withdrawal exception, including reaching 59½, disability, certain medical expenses over a threshold percentage of AGI, and qualified first-time homebuyer expenses up to $10,000.
The basis figure isn’t a one-year number. It determines your tax bill in the year of the conversion, it carries forward on Line 14 to next year’s Form 8606, and it defines what you can pull out of the Roth without a penalty before 59½. Calculate it once, correctly, and record it where you’ll still have it in twenty years.