What if I still have high hopes for a poor-performing investment?
One option is to sell the investment at a loss to generate tax benefits and then reinvest to keep your portfolio intact. For this strategy to work, you must beware of the wash sale rule, which prohibits a loss deduction if you acquire substantially the same security within 30 days before or after the sale. To avoid a wash sale, you can (1) sell the investment at a loss and wait 31 days to reinvest, or (2) buy replacement securities first and wait 31 days to sell the original investment. Either way, you assume the risk of price fluctuations during the 30-day waiting period.
Can I use losses on stocks, bonds or mutual funds held in IRAs, 401(k) plans or other retirement accounts to generate tax benefits?
Unfortunately, in most cases, the answer is no. Traditional IRAs and employer-sponsored plans generally are funded with pretax dollars. Even if they’ve suffered substantial losses, if you sell the investments and close the account, the amount you withdraw will be treated as taxable ordinary income.
You may, however, be able to deduct losses in a Roth IRA, traditional IRA or employer plan if you’ve built up a sufficient tax basis through nondeductible contributions. Suppose, for example, that you’ve made $30,000 in nondeductible contributions to a traditional IRA, but the IRA’s current value is only $20,000. If you close the IRA, you’ll realize a $10,000 loss.
The loss has limited value, though. To deduct the loss you’ll be required to close any other traditional IRAs you own. Plus, the loss can be deducted only as a miscellaneous itemized deduction. Such deductions are subject to a 2 percent of adjusted gross income (AGI) floor, so you’ll enjoy a tax benefit only if your total miscellaneous deductions exceed 2 percent of your AGI.
For a traditional IRA that has lost value, consider converting it to a Roth IRA. Doing the conversion while the IRA’s value is depressed can minimize the tax hit. Plus, if you convert in 2010, you can defer the income and report half on your 2011 return and the other half on your 2012 return.
Are taxes the major consideration?
Investment decisions should never be based on taxes alone. But taking taxes into account in your planning can help improve your after-tax return. Numerous factors must be considered before making an investment decision, including your goals, time horizon and risk tolerance, plus various factors related to the investment itself. Tax considerations are also important, but they shouldn’t be the primary driver of investment decisions. Still, with rates potentially increasing next year, taxes may take a more prominent role.
Check with your tax advisor for the latest information on all time-sensitive facts in this article.
Curtis Campbell is partner-in-charge of the Tax Services department at HMWC CPAs & Business Advisors in Tustin. Contact him at (714) 505-9000 or [email protected].
