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Knowing When IRA Losses are Deductible

Last update on: Apr 21 2016

There are predictable responses to market declines. One response is more people asking, “When can I deduct losses in my IRA?” The disappointing answer is, “Not very often.” The disappointment is understandable. Investment losses have been incurred, so most people think they should be deductible. But generally losses incurred in an IRA aren’t deductible on your individual tax return.

An IRA usually is treated a separate taxpayer. You don’t pay taxes on the IRA’s gains and income (except in a few instances) until they are distributed to you. So, you also can’t deduct the IRA’s losses.

Yet, there are some exceptional situations in which an IRA owner can deduct losses incurred by the IRA. Traditional IRAs and Roth IRAs are treated separately for purposes of deciding when losses are deductible.

For an IRA loss to be deductible on your individual income tax return, the IRA must have a tax basis. When the IRA contributions were deductible or were rolled over from a 401(k) that had only pretax contributions, then the IRA doesn’t have a tax basis. There’s a tax basis only when the IRA has after-tax, or nondeductible, contributions. A Roth IRA is likely to have a basis, since contributions aren’t deductible. A traditional IRA has a basis only when you made contributions that weren’t deductible.

Once you establish that there’s a basis in one or more of your IRAs, to deduct a loss you have to withdraw all funds from all IRAs of the same type (traditional or Roth). When you have a traditional IRA, you must withdraw everything from all your traditional IRAs, SEPs, and SIMPLE IRAs. Even then, you have a deductible loss only when the entire amount withdrawn is less than your total basis in all the IRAs.

After going through all that, if you appear to have a deductible loss, it isn’t deducted on Schedule D against capital gains. An IRA loss is deducted only as an itemized expense on Schedule A. So, you can’t report the loss unless you itemize expenses. Also, the loss is reported as a miscellaneous itemized deduction. You can deduct only the miscellaneous itemized deductions that exceed 2% of your adjusted gross income. You also can’t take that deduction if you are subject to the alternative minimum tax. Plus, if you have a high income your itemized expense deductions might be reduced.

When there’s a loss in your Roth IRA, you have to fully distribute all your Roth IRAs. When the amount distributed is less than your cumulative basis in the Roth IRAs, then you have a deductible loss. You still have to report the loss as a miscellaneous itemized expense subject to the same limitations as for a traditional IRA loss.

The type of investment that incurred the loss in your IRA doesn’t matter. For example, some people lost money on master limited partnerships or real estate investments in their IRAs. When owned personally, these investments are reported on Schedule E of the tax return. In a recent case, a taxpayer tried to deduct the IRA losses on Schedule E. But the IRS and the Tax Court shot him down. The IRA losses can’t pass through to the taxpayer’s Schedule E.

You can see that, while investment losses in an IRA technically are deductible, very few taxpayers will qualify to deduct losses.

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