In your example, converting $50,000 to the Roth, then losing $2k, you could transfer the remaining $48,000 back to the trad, recharacterizing it along the way. File form 8606 to account for the differential. As long as you’ve kept everything separated and have done trustee-to-trustee transfers, no tax is owed on this series of transactions. The net income is included if you’ve had a loss – that is, instead of $50k being transferred back, you’ve included the net income of ($2k), for a total recharacterization of $48k. The reverse would be true if it gained $2k, you’d just transfer back the $52k result (not that you would do this) – still no tax. This is because the recharacterization pretends that the conversion never happened, and you left the funds in the trad, with the resulting $2k loss occurring there.

Does that clear it up?

jb

When I read the IRS pub 509, it seems to me that you have to recharacterize the amount converted plus earnings (positive or negative). So if I convert $50k to a Roth and it loses $2k, if I recharacterize the full amount, I can only recharacterize $48k, and I’ll owe tax on the remaining $2k, though I’ll have nothing to show for it.

“Recharacterizations

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution.

To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following.

* Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount….”