racially retarded is a word used for people who do not see skin color or origins. It's kind of hard for them to understand that someone is from another ethinicity. They treat everyone the same in an unbiased way and in some cases it takes them awhile to see that people that they meet are different from them.
Sam: I think I'm gonna get a tan this summer. Would like to come with Jill.
Jill: Umm.... No thanks. I don't need a tan. I'm already brown?
Sam: Oh! You are! *surprised*
Jill : Sometimes I think you're racially retarded.
The example sucks but I think you guys get the point.