How To Deduct Losses On IRA Accounts

It’s all about establishing basis

A loss can only be recognized on an IRA account once the funds have been withdrawn and the value is less than the cost basis of the account. There can be no tax loss on sale transactions inside the IRA. Whenever contributions are invested in IRAs on an after tax basis, cost basis is established. Nondeductible IRAs have a cost basis. ROTH IRAs have a cost basis. Both of those types of IRA accounts were established with after-tax dollars.

The tax rules require that the entire balance of the IRA account to be claimed as a loss must be withdrawn. The tax rules also require that all IRA accounts must be distributed before a loss can be claimed. That is the IRS’s way of attempting to limit or wipe out a loss deduction on one IRA account if there are other IRA accounts in existence.

Tax losses on IRAs are claimed as Miscellaneous Itemized Deductions, subject to the 2% of adjusted gross income limitation and subject to the phaseout limitations on overall itemized deductions. They cannot be claimed as a capital loss, to be offset against capital gains.

If the year in which the IRA tax loss is contemplated or actually transacted results in the IRA owner being subject to the Alternative Minimum Tax, the deduction for the loss will be lost. Miscellaneous Itemized Deductions are added back to taxable income in computing Alternative Minimum Taxable Income.

If some IRA accounts are in a loss position, and others are in a profit position so that the net position is either even or a slight profit, the best strategy may be to take a long-term view and wait for better economic times.

If the IRA account which has a loss was a converted IRA, one remedy may be to recharacterize the conversion as if it never happened so that at least you can recapture any tax paid on the conversion. However, the deadline for recharacterization is October 15th of the year following the year for which the conversion was made.