IRA Cost Basis: Form 8606, Pro-Rata Rule, and Roth Conversions

The cost basis of an IRA is the running total of after-tax dollars you’ve put into it, and tracking that number is what keeps you from paying income tax twice on the same money. Basis applies to traditional, SEP, and SIMPLE IRAs. Every dollar you can document comes back to you tax-free when you take distributions; every dollar you can’t gets taxed as if it were pre-tax money. The IRS puts the entire burden of proof on you, and lost records cost real money.

What Creates Basis in an IRA

A traditional IRA contribution only creates basis when you don’t deduct it on your tax return. If you claim the full deduction, the whole contribution is pre-tax, basis is zero, and every penny is taxable when it eventually comes out.¹

Nondeductible contributions happen most often when income is too high to qualify for the deduction. If you’re covered by a retirement plan at work and your Modified Adjusted Gross Income exceeds the IRS phase-out range for your filing status, part or all of your contribution becomes nondeductible. Anything you contribute that you cannot deduct becomes basis in the account.

After-Tax Rollovers From Employer Plans

Some 401(k) and 403(b) plans allow after-tax contributions on top of regular salary deferrals. When you leave the employer and roll that after-tax money into a traditional IRA, it immediately becomes part of your IRA basis.² The earnings on those after-tax contributions remain tax-deferred and do not count as basis. The Form 1099-R you receive for the rollover shows the after-tax portion in Box 5.³

Roth IRAs Work Differently

Basis tracking in the sense described here is a traditional, SEP, and SIMPLE IRA concern. Qualified Roth distributions come out tax-free, so there’s no need to separate basis from earnings. If you tap a Roth before age 59½ or before the account has been open five years, ordering rules apply and your contribution basis still matters, but the mechanics below are about pre-tax accounts.

Tracking Basis With Form 8606

Form 8606, “Nondeductible IRAs,” is the only mechanism the IRS recognizes for tracking IRA basis. You have to file it in any year you make a nondeductible contribution to a traditional IRA, even if your income is low enough that you otherwise wouldn’t file a return.⁴ You also file it in any year you take a distribution from a traditional, SEP, or SIMPLE IRA that contains basis.⁵

The form works as a running ledger. Part I records this year’s nondeductible contribution and adds it to the basis carried forward from prior years. Each year’s ending balance becomes the next year’s starting balance, linking every after-tax contribution you’ve ever made into a single cumulative number.⁶ When a distribution happens, the same Part I calculates how much of it is tax-free.

If you aren’t filing a Form 1040 for the year, send Form 8606 on its own, signed, to the same IRS address and by the same deadline (including extensions) as a return.⁴

The IRS Does Not Track This for You

This is where most people get tripped up. Your IRA custodian reports contributions to the IRS on Form 5498 and distributions on Form 1099-R, but the custodian is not required to tell the IRS whether a contribution was deductible or nondeductible, and neither form reports your cumulative basis.³ The IRS has no centralized database of IRA basis. If you take a distribution years from now and can’t produce the chain of Forms 8606, the IRS will treat the entire distribution as taxable.

Records to Keep

The IRS instructions say to keep these records until every dollar has been distributed from all your IRAs:

Each year’s Form 8606 and supporting worksheets
Page 1 of your Form 1040 for every year you made a nondeductible contribution
Form 5498 statements from your custodian showing contributions and year-end account values
Form 1099-R for every year you took a distribution

“Until all distributions are made” is effectively indefinite for most people. Digital copies are fine; keep them backed up.

How Basis Comes Out: The Pro-Rata Rule

You can’t cherry-pick which dollars come out of your IRA. Every distribution is a proportional mix of taxable and tax-free money. The formula:

Tax-free portion = (Total basis ÷ Total value of all non-Roth IRAs) × Distribution amount

Total basis is the cumulative figure from your most recent Form 8606. Total value is the combined fair market value of every traditional, SEP, and SIMPLE IRA you own as of December 31 of the distribution year, plus any outstanding rollovers.⁴

The Aggregation Rule

The IRS treats all your non-Roth IRAs as a single pool for this calculation. It doesn’t matter that you opened the accounts at different custodians in different years. Say you have one IRA with $50,000 (containing $10,000 of basis) and another with $150,000 (all pre-tax). Your total is $200,000 with $10,000 of basis.

Withdraw $10,000 from the first account and the tax-free portion is ($10,000 ÷ $200,000) × $10,000 = $500. Only $500 comes out tax-free. The other $9,500 is taxable as ordinary income. The aggregation rule eliminates any strategy of concentrating basis in one account and draining it first.² After each distribution, your remaining basis drops by whatever tax-free amount came out, and that reduced number carries forward to next year’s Form 8606.

Basis in Roth Conversions

The pro-rata rule applies to Roth conversions exactly the way it applies to any other distribution. A conversion is a taxable event, but the portion representing after-tax basis moves over tax-free. Only the pre-tax contributions and earnings owe income tax in the conversion year.

Suppose you have $10,000 of basis across $100,000 in total traditional IRA assets and convert $50,000. The tax-free portion is ($10,000 ÷ $100,000) × $50,000 = $5,000. You’d owe ordinary income tax on $45,000. Every traditional, SEP, and SIMPLE IRA you own goes into the denominator, including accounts you aren’t converting. Part I of Form 8606 handles the pro-rata split, and Part II reports the taxable amount; your remaining basis is then carried forward.⁵

The Backdoor Roth Trap

High earners who can’t contribute directly to a Roth often use a two-step workaround: make a nondeductible contribution to a traditional IRA, then convert it to a Roth. With no other traditional IRA balances, the conversion is nearly or entirely tax-free because basis equals the amount being converted.

Pro-rata is what makes or breaks this. If you have existing pre-tax money in any traditional, SEP, or SIMPLE IRA, you cannot isolate the nondeductible piece. Someone with $92,500 of pre-tax IRA money who makes a $7,500 nondeductible contribution and tries to convert only that $7,500 will find roughly 92.5% of the conversion taxable. Some people roll their pre-tax IRA balances into an employer plan (where the plan accepts incoming rollovers) before executing the conversion, leaving the traditional IRA holding only the nondeductible contribution. On Form 8606, you report the nondeductible contribution on Line 1, record the conversion on Line 8, and the form walks through the pro-rata math. If the only traditional IRA money is the nondeductible contribution, Line 18 of Part II should show zero taxable income.⁷

Inherited Basis

Basis does not disappear when the owner dies. It carries over to the beneficiary and reduces tax on inherited distributions.⁸ Practically, that means beneficiaries need access to the decedent’s last Form 8606.

A surviving spouse who treats the inherited IRA as their own can combine the inherited basis with any basis they already have in their own traditional IRAs. Every other beneficiary must keep inherited basis separate from personal basis. If you inherit IRAs from more than one person, you file a separate Form 8606 for each decedent’s IRA.⁴

Penalties and Fixing Past Mistakes

The direct penalties for Form 8606 errors are small. The downstream tax cost is not.

Failure to file: $50 for each year you were required to file Form 8606 to report a nondeductible contribution and didn’t.⁴
Overstating basis: $100 for each overstatement of nondeductible contributions, unless you can show reasonable cause.⁶

The real cost of skipping Form 8606 isn’t the $50. It’s that years later, when distributions start, you’ll have no proof of your basis and the IRS will tax money you already paid tax on.

Filing Form 8606 for Prior Years

If you made nondeductible contributions in past years and never filed Form 8606, you can still file retroactively. Prepare the form for each missed year, using that year’s version where possible, and submit it. If the omission should have changed a previously filed return, file Form 1040-X with the corrected Form 8606 attached. The IRS instructions note that changes generally must be made within the time limit for filing an amended return, but filing a late Form 8606 to establish basis is better than losing the basis entirely.

Reconstructing Lost Records

If you’ve lost your Forms 8606, start by requesting transcripts of past tax returns from the IRS using Form 4506-T. The transcripts may show whether you claimed IRA deductions in prior years. Cross-reference them against the Form 5498 statements from each custodian, which show how much you contributed each year. Any year where you contributed but didn’t deduct likely generated basis. Old bank and brokerage statements and canceled checks help fill in the timeline. The process is tedious. The tax savings from recovering a legitimate $20,000 or $30,000 of basis usually justify the effort.

1
Internal Revenue Service. Topic No. 451, Individual Retirement Arrangements (IRAs)
2
Internal Revenue Service. Rollovers of After-Tax Contributions in Retirement Plans
3
Internal Revenue Service. Instructions for Forms 1099-R and 5498 (2025)
4
Internal Revenue Service. Instructions for Form 8606 (2025)
5
Internal Revenue Service. About Form 8606, Nondeductible IRAs
6
Internal Revenue Service. Publication 590-A (2025), Contributions to Individual Retirement Arrangements (IRAs)
7
Internal Revenue Service. Form 8606 – Nondeductible IRAs
8
Internal Revenue Service. Publication 590-B (2025), Distributions From Individual Retirement Arrangements (IRAs)