If you're IRA lost money in a stock-market downturn, or if you've cashed out your IRAs, you may wonder if you can write off an IRA account loss like you would a taxable investment account. It's worth considering, especially if you're facing early withdrawal penalties, but the unfortunate truth is that while you can write off losses in certain circumstances, it's unlikely to make a difference for most people.
Full Cash Out
In order to take a deduction for an IRA loss, you must cash out all your similar IRAs. The IRS views all IRA accounts following the same rules -- Roth or traditional -- to be one IRA. This means if you are taking a loss from a Roth IRA, you must cash out all your Roth IRA accounts, and all accounts factor into the loss calculation. The same is true for traditional IRAs.
If you want to take a loss, you have to have a starting point from which to calculate that loss, which is known as your tax basis, or cost basis. In a taxable account, you purchase securities with taxed money. When you sell them, you can deduct the value of your original purchase from your gain, so you're only taxed on the new money. If you have a loss, you can deduct that from your taxable income, almost as if you had never earned that money. When you contribute to a traditional IRA, you deduct the value of that contribution from your taxable income -- you don't pay tax. This means that you have no tax basis for securities purchased with deductible traditional IRA contributions, and cannot recognize a loss. For non-deductible and Roth contributions, the total value in your accounts must be less than your total taxed contributions -- your basis -- to take a loss.
Two Percent Floor
The IRS does not allow IRA losses to count against other investment gains like it does in taxable accounts. Instead, the loss counts as a miscellaneous investment expense. You must itemize your deductions, and your total investment expenses must be greater than 2 percent of your adjusted gross income for the year. You can add additional investment expenses to your IRA loss to meet the 2 percent floor -- see IRS Publication 550 for a complete list of eligible expenses.
If you are subject to the Alternative Minimum Tax, you cannot take a loss from IRA accounts to reduce your income. It's also important to remember that cashing out your IRA means that you lose all tax benefits on that money, and you may incur withdrawal penalties if you are under age 59 1/2.
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