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Is there a tax benefit for an IRA wipeout?

September 30, 2008

When you lose your shirt in a taxable brokerage account, you get a capital loss. Those losses are subject to a sometimes painful limit - capital gains plus $3,000 per year - but at least there's hope for future gains to offset them, or a very long life.

But what if you lose your shirt in an Individual Retirement Account? Earnings inside IRAs are non-taxable, and that's great when they make money, but when they lose, they don't give you a tax benefit.

There is a way to get a tax benefit from some IRAs. Unfortunately, it's hard to get, and it will be useless to many taxpayers.

If you have either non-deductible traditional IRAs or Roth IRAs, you can get a deduction for losses in the IRA. If your losses are in traditional non-deductible IRAs, you have to close out all of your traditional IRA accounts to get the deduction; if it's in a Roth IRA, you likewise have to close all of your Roth IRAs and distribute the proceeds to yourself. Your deduction is then the amount your basis in the closed-out IRAs exceeds what was left in them. Traditional deductible IRAs have no basis (because you deducted your contributions), so they give you no deduction.

But wait, it gets worse. Any deduction you get is a miscellaneous itemized deduction. That means you only get a benefit if you itemize, and only to the extent the loss exceeds 2% of your adjusted gross income. It also means the loss doesn't count at all in computing alternative minimum tax.

The moral? There's no such thing as a good loss, but IRA losses may be the worst.

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