Deducting Losses on Roth IRA Investments

It makes sense when we say that greater risk has the potential of yielding greater returns. If you do not want to take risk, you would invest your money in certificates of deposit or money market funds that provide a risk-free interest rate upon maturity. However, these interest rates are lower than the percentage returns provided by riskier stocks. If you make losses on your IRA (Individual Retirement Account) investments, you can deduct them from your tax return ONLY if certain conditions are fulfilled. We look at these conditions next:

1) Withdraw Full Balance to Claim Losses

In order to be eligible to claim losses on your tax return from your IRA investments, you MUST withdraw the entire balance from that account. For example, if you faced a loss of $5000 this year on your Roth IRA account, you must withdraw the full balance from your Roth IRA in order to be eligible to deduct this $5000 allowable capital loss from your tax return. On the other hand, if you faced a similar loss from your SEP IRA, SIMPLE IRA or Traditional IRA, you must withdraw the entire balances from all these Traditional IRAs in order to deduct any losses.

2) Losses on your Traditional IRA

You can deduct losses made on your Traditional IRA only if:

the total balance you withdraw is LESS than the after-tax amounts (basis amounts) remaining in your Traditional IRA.
the IRA basis is any non-deductible contributions + after-tax IRA rollovers from 403b plans, 457 plans or other qualified retirement plans.
you fill out IRS Form 8606 which is used to determine the basis of your withdrawal amounts from your Traditional IRA. IRS Form 8606 is also used to calculate your actual IRA loss to be included in your income tax return, and the total amount of your IRA withdrawal.

Example of a Traditional IRA Investment Loss

Beginning January 1st, 2004, John had a Traditional IRA balance of $30,000.
$20,000 is the After-Tax balance
On December 31st, 2004, John's IRA lost $13000 in value. This means his Traditional IRA balance is now: $30,000 - $13000 = $17,000
This $17000 is now less than the after-tax balance of $20,000.
This means John can claim a loss on his income tax return if he withdraws his total balance from his Traditional IRA.
His income tax loss deduction would be calculated as follows:

$30,000 January 1st, 2004 Balance
- $13000 IRA Investment Loss for the year 2004
$17,000 Value of his Traditional IRA at Dec 31st, 2004

$20,000 After-Tax Basis Amount
- $17,000 Value of his Traditional IRA at Dec 31st, 2004
$3,000 His Income Tax Deduction from IRA Investment Losses - 2004

Example of a Roth IRA Investment Loss

Beginning January 1st, 2004, John had a Roth IRA balance of $20,000.
Of this Roth IRA balance, $12000 is attributed to Earnings and $8000 is attributed to contributions.
Since Roth IRA contributions are non-deductible for tax purposes, the entire $8000 of contributions is considered an after-tax basis amount.
During 2004, John's Roth IRA lost $2000 in value, declining his Roth IRA's total value to $18000 ($20,000 - $2000).
Since this $18,000 is more than the basis amount of $8000 (after-tax), John is NOT eligible to deduct this loss from his income tax return if he withdraws the entire balance from his Roth IRA.
Here's the calculation:

$20,000 January 1st, 2004 Balance
- $2000 Losses on the Roth IRA Investment
$18,000 Value of his Roth IRA at Dec 31st, 2004

$8000 After-Tax Basis Amount
- $18,000 Value of his Roth IRA at Dec 31st, 2004
$-10,000 This $10,000 is NOT deductible from his income tax return.


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