Q. If I close my IRA by converting the funds to a Roth IRA, can I deduct losses from a non-IRA account against profits gained in my IRA?
A. We see what you’re getting at, but it doesn’t work that way.
When you withdraw funds from an IRA account, you must pay federal and state income tax on the taxable amount of the withdrawal.
The taxable amount is the excess amount over the IRA’s “basis,” said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
There are two ways to get basis in an IRA.
The first is when you make a non-deductible contribution to your IRA, Kiely said.
“If you participate in a pension at work and earn too much, you can contribute to your IRA,” he said. “You just can’t take a deduction for the contribution on your federal income tax return.”
So the amount you contribute to your IRA becomes your “basis.”
As long as you keep track of your basis, Kiely said, you will never pay income taxes on it.
“Since New Jersey never allowed a tax deduction for IRA contributions, any contributions you made to an IRA has basis for state tax purposes,” he said.
The second source for basis is when you make after-tax contributions to your 401(k) at work.
In 2018, the law allows you to contribute $18,500 to your 401(k) plan on a pre-tax basis, Kiely said. This means you don’t pay federal or state tax on the contribution.
What happens if you contribute $20,000 to your 401(k) plan?
“You contributed $18,500 in pre-tax contributions and $1,500 in after-tax contributions,” he said. “You now have $1,500 in basis in your 401(k). If you rolled your 401(k) plan into an IRA, you would roll the $1,500 of basis into a Roth IRA and the remaining balance into a taxable IRA.”
Roth IRAs were created by the Tax Relief Act of 1997, Kiely said. Prior to Roth IRAs, if you had after-tax contributions in your 401(k), you would roll over the entire account into one IRA account. The after-tax contributions would have resulted in basis.
So what happens if purchase an investment in your IRA and that investment loses value? Is there any income tax relief available?
The short answer is no.
Federal and state income taxes are based on the amount in excess of basis that is withdrawn from the account, Kiely said. There is no treatment of gains or losses in an IRA. You are taxed on the amount you take out.
“Let’s say you invested $100,000 in GE stock in an IRA and then it dropped to $25,000 and you took out the $25,000,” Kiely said. “You would pay tax on the $25,000. There are no adjustments for investment losses.”
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