Tax

Understanding IRA Basis: Traditional vs. Roth IRAs

August 24, 2026

Susan E. Wendt, EA

Do you know that part of the money in your Traditional IRA may already have been taxed once? The IRS does not keep track of which part is taxable or nontaxable; you do. The nontaxable portion, made up of after-tax dollars, is called your basis, and if you cannot prove it, you will pay tax on the same money twice.

Insight: Most Traditional IRA distributions are taxable, and most Roth IRA distributions are tax-free. Basis is the exception that sits between them, and it is the one piece of the calculation nobody else is holding for you.

What Creates Basis in a Traditional IRA?

You have basis in a Traditional IRA if any of the following applies.

Nondeductible contributions: usually because a workplace retirement plan limited the deduction on your own IRA contribution, or because you did it on purpose as part of a backdoor Roth strategy. Income does not stop you from funding a Traditional IRA; it phases out the deductible portion, and only when a workplace plan covers you or your spouse. For 2026, the deduction phases out between $81,000 and $91,000 for a single filer covered at work, and between $129,000 and $149,000 for a married couple filing jointly when the contributing spouse is covered.
After-tax rollover amounts from another plan, such as a 401(k): the after-tax portion keeps its character when it lands in your IRA.
Inherited IRAs that include basis amounts. The decedent’s basis carries over to you as the beneficiary, but it is your responsibility to prove the amount.
Repayments or recontributions: qualified reservist distributions, and certain disaster, birth-or-adoption, and emergency withdrawals that you put back into an IRA.

Keep in mind that only the nondeductible portion of your contributions creates basis. Any earnings on those contributions are fully taxable when withdrawn.

Why Basis Tracking Falls on You

The IRS does not track your basis. Neither does your custodian. You do, by filing Form 8606 each year. Other documents you receive, like Form 5498, report what went into the account, not whether you deducted it. Without your own records, those same dollars get taxed twice, often years or decades later when the paperwork is gone.

Form 8606 tracks your basis year by year and allows you to split every future distribution into its taxable and tax-free parts. Just as important, it hands future preparers a number they can rely on.

The Pro-Rata Rule: You Cannot Withdraw Only the After-Tax Money

This is where most people go wrong. You cannot choose to take the after-tax dollars out first. Every distribution comes out in a proportional mix: part taxable, part not. Two figures set the proportion.

Insight: All of your Traditional, SEP, and SIMPLE IRAs are treated as one account for this calculation (IRC Sec. 408(d)(2)). (Parking your nondeductible contributions in their own IRA does not give that account an answer of its own.)
The numerator is the total amount of basis in all of these accounts.
The denominator is the total value of these accounts on December 31, plus anything you distributed or converted during the year; it is not the balance you started with.

Example: You took a $12,000 distribution during the year. At December 31, your Traditional IRAs are worth $38,000 and your basis is $10,000. First you add back the $12,000 you withdrew; that becomes the denominator of $50,000. You divide your basis of $10,000 by the $50,000, which gives you 20%. The distribution is taxed or not taxed as follows:

$2,400 tax-free ($12,000 × 20%)
$9,600 taxable (the remaining 80%)

Your new basis amount carries forward and is calculated as follows: $10,000 less the $2,400 you just recovered, leaving $7,600. That is your starting basis for next year’s Form 8606.

How Basis Is Tracked: Form 8606

If you make a nondeductible contribution or have after-tax funds in your IRA, you must file Form 8606 for that year, and continue updating it annually to include future nondeductible transactions (including inherited IRAs with basis). Three rules catch people by surprise:

Basis is personal. If both spouses have nondeductible contributions, each spouse files a separate Form 8606; both forms are included on their joint return but never combined into one Form 8606.
Each inherited IRA gets its own form. File a separate Form 8606 for the IRA inherited from each decedent.
There are penalties. Failing to file when required costs $50; overstating your nondeductible contributions costs $100. Both may be waived for reasonable cause (IRC Sec. 6693(b)).

But the penalty is not the real cost. The real cost is the basis you can no longer prove or use. Now tax-free dollars convert into taxable ones for the rest of the account’s life.

Traditional vs. Roth IRA Basis

Traditional IRA: Basis is after-tax contributions tracked on Form 8606 and reduces the taxable portion of every distribution for as long as the account exists.
Roth IRA: Contributions are already after-tax and can generally be withdrawn tax-free if specific IRS guidelines are followed. Conversions and rollovers need to be tracked separately (also on Form 8606), and we recommend keeping your own records of your Roth contributions. The IRS does not require Form 8606 for ordinary Roth contributions, which creates problems for tracking them later.

A Quick Note on Roth Distributions

Roth IRAs follow ordering rules:

Contributions (basis) come out first (tax-free)
Then conversions
Earnings last

Earnings are taxable only if the withdrawal is not qualified. A qualified withdrawal needs two things: five tax years since your first Roth contribution, and a triggering event (age 59½, disability, death, or a first home purchase).

There is a second five-year clock, and it is a different rule. Each conversion runs its own five-year period governing the 10% early-withdrawal penalty on the converted dollars. One clock decides whether earnings are tax-free; the other decides whether converted money escapes the penalty.

Where We See This Go Wrong

Three patterns account for most of the basis problems that come through our office.

Backdoor Roth conversions with a pre-tax IRA in the background. For example, a client sets up a separate IRA account, makes a $7,500 nondeductible contribution and converts it the same week, expecting a tax-free conversion. If the client also has a $200,000 rollover IRA held at another firm, the pro-rata rule pulls it into the math: $7,500 × ($7,500/$207,500), so only about $271 of that $7,500 conversion is tax-free, and roughly $7,229 is taxable income. The rule does not care that the accounts are at different institutions.

Inherited IRAs. Beneficiaries rarely receive the decedent’s Form 8606, and that basis is real money. We ask for it during estate administration, while the prior returns are still findable, not five years later when the first large distribution lands.

Self-directed IRAs holding digital assets. The pro-rata denominator is a December 31 fair market value. For an IRA holding tokens rather than mutual funds, that value takes real work to support, and it changes the taxable portion of every distribution taken that year.

What to Do This Month

Basis is reconstructed from paper, and paper disappears. Pull your retirement account records together now, including basis amounts, and keep them until the last dollar has left your IRAs.

Your IRA basis file
Page 1 of every Form 1040 for a year you made a nondeductible contribution Every Form 8606 you have ever filed, with attachments and worksheets Forms 5498 showing contributions and December 31 account values Forms 1099-R for every year you took a distribution For Roth IRAs: your own running record of contributions and conversions by year

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