Recently, someone asked me if they could deduct losses they incurred in their Roth IRA. Here’s my response…
You can deduct losses in a Roth IRA, but the rules and treatment are different than you might expect. First, in order to claim a loss in any IRA investment, you must withdraw the entire balance from all of your IRAs of the same type. So, if you have a loss in your Roth IRA, you must liquidate all of your Roth IRAs in order to deduct the loss on your tax return.
Second, your basis in your Roth IRA includes your contributions plus conversions (from a traditional IRA) less any withdrawals you have previously taken from your Roth. Form 8606, Non-Deductible IRAs, is used to determine the basis in your account and to
report withdrawals. Note that reinvested dividends and capital gains are not part of your basis in a Roth IRA.
Finally, losses in a Roth IRA are deducted on Schedule A – Itemized Deductions, rather than on Schedule D – Capital Gains and Losses, which is where most people would expect to report the loss. Roth IRA losses are a miscellaneous deduction, subject to a 2% floor. This means that the deduction is only available if you itemize your deductions, and only the amount greater than 2% of your adjusted gross income (AGI) is deductible. In addition, miscellaneous deductions are not allowed for purposes of the alternative minimum tax (AMT), so you could lose the benefit of the deduction if you are subject to AMT taxes.
Whether it makes sense to liquidate your Roth IRA to claim the loss will depend on several factors, such as whether you itemize or not, how large the loss is compared to 2% of your AGI, whether you’re subject to AMT tax, and other factors. You should also consider how much will you lose in potential earnings if you liquidate your Roth IRA. You may want to consult with your tax advisor and financial planner to determine the best decision for you at this time.