We all hope that our investments will produce profitable returns. And while you can get guaranteed results on some investments such as certificate of deposits and money market funds, these investments usually render a lower potential return than high-risk investments. As such, you might prefer some riskier investments, but the opportunity for greater returns comes with the higher potential for losses. In regular accounts, in which taxes are not deferred, losses on investments can be included on your tax return. (see Selling Losing Securities for a Tax Advantage) However, losses on investments in IRAs can be claimed only if certain requirements are met.

Withdrawing Balances to Claim Losses In order to claim a loss on IRA investments, you must withdraw the entire balance from all your IRAs of the same type. For instance, if the loss occurred in a Traditional, SEP or SIMPLE IRA, you must withdraw the balances from all your Traditional, SEP and SIMPLE IRAs (hereinafter collectively referred to as Traditional IRAs). If the loss occurred in a Roth IRA, you must withdraw balances from all your Roth IRAs in order to include the loss on your tax return

Traditional IRA Losses You may deduct your Traditional IRA losses only if the total balance that you withdraw is less than the after-tax amounts (basis amounts) in your Traditional IRAs. Your IRA basis is attributed to non-deductible contributions and rollovers of after-tax amounts from qualified plans, 403(b) accounts and 457(b) plans.   You must file IRS Form 8606 to determine the basis of the amounts you withdraw from your Traditional IRAs. Form 8606 serves also to indicate to the IRS which portion of your withdrawal is attributed to after-tax amounts and the amount that is eligible to be claimed as a loss on your tax return. Form 8606 and its accompanying instructions are available at www.irs.gov.

Example 1 At the beginning of 2005, Tim’s aggregate Traditional IRA balance is $20,000, of which $15,000 is attributed to after-tax amounts. By Dec 31, 2005, the investments in Tim’s Traditional IRAs lost $8,000, leaving his balance at $12,000. This amount is less than the basis amount of $15,000, so Tim may be eligible to claim a loss if he withdraws his total Traditional IRA balance. His deduction would be the difference between the balance he withdraws ($12,000) and his basis. Here is how the deduction is determined:   $20,000  (Jan 5 Traditional IRA balance) - $8,000  (Losses over the year ) $12,000  (Dec 31 Traditional IRA balance)       $15,000  (Basis amount) - $12,000  (Balance on Dec 31)     $3,000  (Deduction for Traditional IRA losses)

Roth IRA Losses The same rules apply to the Roth IRAs: claiming Roth IRA losses on your tax return is allowed only if the total of your Roth IRA balances are withdrawn and the amount withdrawn is less than the basis in your Roth IRAs. 

Example 2 At the beginning of 2005, Tim’s Roth IRA balances are $10,000, of which $6,000 is attributed to earnings and $4,000 is attributed to contributions. Since Roth IRA contributions are non-deductible, all contributions are considered after-tax amounts (basis amounts). During 2005, Tim’s Roth IRA investments lost $2,000, leaving his balance at $8,000. This amount is more than the basis amount of $4,000, so if Tim withdraws his entire Roth IRA balance, he will not be able to include the losses on his tax return:   $10,000 (Jan 5 Roth IRA balance) - $2,000 (Losses)   $8,000 (Dec 31 balance)      $4,000 (Basis amount)  $8,000 (Less Dec 31 balance) -$4,000

Claiming the Loss Miscellaneous itemized deductions on Schedule A of Form 1040 are limited to 2% of adjusted gross income. The losses claimed on IRA investments are subject to this limit. Your tax professional should be able to assist you with determining the amount you may include on your tax return.

Conclusion Be sure to consult with your financial advisor and tax professional before deciding to withdraw your IRA balances, especially if the sole purpose of making the withdrawal is to claim losses on your tax return. Your tax professional will be able to determine whether you are eligible to claim the loss. And your financial advisor should be able to assist you with determining whether it makes financial sense to withdraw all your IRA balances. He or she should also analyze your chances of recovering the losses in your IRA while you continue to enjoy tax-deferred or tax-free growth (in the case of Roth IRAs).

by Denise Appleby (Contact Author | Biography)

Denise Appleby is a retirement plans consultant, freelance writer and editor. Before starting her own business, Appleby Retirement Consulting, Denise worked for Pershing LLC for almost 10 years. While at Pershing, Denise rose to the rank of vice president, and held many positions including retirement plans product manager, manager of the retirement plans technical assistance group and retirement plans training manager. Appleby Retirement Consulting provides technical assistance to financial institutions and financial professionals; content for newsletters, websites and magazines; and technical editing services for books and other retirement plans material. Denise holds several retirement professional designations.