From time to time I get emails asking whether it’s possible to claim a deduction for a loss in an IRA.
Yes, it’s possible. But the rules for deducting an IRA loss are so restrictive that it’s a non-option for most investors. Specifically, there are three reasons why most taxpayers won’t be able to gain any tax benefit from a loss in their IRA.
You Can’t Claim a Loss on a Per-Investment Basis
In a taxable account, you can sell an investment that’s currently worth less than your cost basis (which, in most cases, is what you paid for the investment) and claim a loss. In an IRA, you can’t claim a loss on a per-investment basis. The whole IRA needs to be worth less than your basis in the IRA.
- For a Roth, your basis is equal to the sum of your Roth contributions.
- For a traditional IRA, your basis is equal to the sum of your nondeductible traditional IRA contributions. (Note: This means that for many investors, their basis in their traditional IRA is zero, and, therefore, they cannot claim a loss no matter how low the value of their IRA goes.)
Also, for purposes of deducting a loss in an IRA, all your Roth IRAs are considered to be one Roth IRA, and all your traditional IRAs are considered to be one traditional IRA.
Example: In 2009, Jerry opened his first Roth IRA with a $5,000 contribution. In 2010, he opened another Roth IRA (at a different brokerage firm) with a $5,000 contribution. At the end of 2010, one IRA is worth $4,000, and the other is worth $7,000. Even though one IRA is worth less than his initial contribution, Jerry cannot claim a loss because the combined value of his Roth IRAs is greater than his basis ($10,000).
You Must Distribute the Entire IRA
The second reason many investors can’t benefit from the ability to deduct IRA losses is that, in order to claim the loss, you have to have all the money in the account distributed to you. That is, you have to withdraw every dollar from the IRA. (Or, more specifically, you have to withdraw every dollar from all your IRAs of that type, because, as we just discussed, they’re all considered to be one IRA.)
The reason this can be a problem is that taking IRA distributions to claim a loss does not exempt you from the 10% penalty if you’re under 59½. As such, unless you meet one of the other exceptions to the penalty, the extra 10% tax will almost surely negate the benefit of being able to deduct your IRA loss.
Note: In the case of a Roth, this is a non-issue, as you can take Roth IRA withdrawals up to the amount of your contributions without paying tax or penalty. (And your contributions are obviously greater than the IRA’s current value, otherwise there would be no loss for you to consider deducting.)
It’s a Miscellaneous Itemized Deduction
The final reason that most investors can’t benefit from claiming an IRA loss is that the deduction you get is a miscellaneous itemized deduction. You can only deduct the loss the extent that it (plus your other miscellaneous itemized deductions) exceeds 2% of your Adjusted Gross Income.
And even then, you only receive a benefit from the deduction if it (plus your other itemized deductions) exceeds your standard deduction for the year.