Question: I have been contributing to my IRA account for five years. I will be 60 next year, when I plan to retire. Because I was also covered by my employer’s retirement plan, I was never able to deduct my IRA contributions. The investments I picked didn’t do well and my IRA is now worth less than the sum of my contributions. If I take the money from my IRA, will I have to pay taxes on it or will I be able to claim my loss?
Answer: Timely question! When Congress authorized IRA accounts, I don’t think it considered the possibility of a loss. IRA accounts are savings for retirement, and who would ever think that their retirement savings would eventually add up to less than the amount they contributed?
Distributions from retirement accounts, including IRA accounts, are taxable to the extent that the amount of the distribution exceeds the tax basis. In your situation, the tax basis in your IRA account is the sum of each year’s nondeductible contribution. If your total contributions add up to $20,000 and they were not deductible, then your tax basis would also be $20,000. If the value of your IRA had grown to $30,000 and you withdrew the entire amount, you would have to pay income tax on $10,000 — the difference between the amount you took out and the amount you put in.
In your case, the amount now in your IRA is less than your tax basis, so you can deduct the loss. Here’s an example. Let’s assume your contributions totaled $20,000 and your account is now worth $12,000 and you withdraw the entire amount. Potentially, you have an $8,000 deductible loss. Here are the steps you must follow to claim it:
1) You must withdraw all the money in your traditional IRA account (and if you have more than one traditional IRA account, you must withdraw all the money from those accounts, too).
2) If the total amount you take out is less than your total tax basis in the account, then you have a loss that you can claim on your tax return.
3) When you prepare your income tax return, you will report the $12,000 withdrawal on the front page of your Form 1040 as the gross amount of your IRA distribution. On the same line, you will report a taxable amount of zero.
4) You can claim your $8,000 loss as a miscellaneous itemized deduction on Schedule A subject to the limit of 2 percent of your adjusted gross income. So you add the $8,000 loss on your IRA to your other miscellaneous itemized deductions (tax preparation fees, deductible employee expenses, deductible investment expenses, etc.).
5) Don’t forget to exclude your miscellaneous itemized deductions when you figure your alternative minimum tax (AMT). If your AMT is higher than your regular tax, then you lose some or all of the deduction for the loss in your IRA.
If you are lucky and you make it through the above IRS hoops, you get to deduct the loss.
Kenneth B. Petersen is an investment adviser and principal of Monterey Private Wealth Inc. in Monterey. Send questions concerning investing, taxes, retirement or estate planning to 2340 Garden Road, Suite 202, Monterey 93940 or email@example.com.