Deducting Losses in Roth IRAs Might Not Be Worth the Effort
Question: My wife and I contribute the maximum allowed to our Roth IRA accounts, including the catch-up contributions. (We're 63.) We know that gains in our Roths are not considered taxable income, either when the gains occur or when we withdraw the money. Please tell us if losses in our Roths are tax deductible, and if so, when is the loss reported to the IRS? Do we report the loss when we sell the losing investment or when we withdraw the funds? No one seems to know how to handle losses in the Roth IRA.
Answer: For a while after Roth IRAs were created, there was confusion on this point. But several years ago the IRS spelled out what you need to do to deduct a Roth IRA loss in its helpful Publication 590, "Individual Retirement Arrangements."
Once you read the instructions, though, you'll probably change your mind about actually doing this.
To deduct a loss in a Roth IRA, the taxpayer has to first completely liquidate, withdrawing all the money from the account -- and any other Roths he or she might own. If the total of all the withdrawals is less than the taxpayer's basis, then the loss is potentially deductible, said Nicholas Kaster, senior pension law analyst for tax research firm CCH Inc. (Your basis in your Roth is all the contributions you've made over the years, minus any withdrawals.)
Unlike most other investments, this loss isn't considered a capital loss. Instead, it's considered a "miscellaneous itemized deduction," reported on Schedule A. To get any tax break, you have to be able to itemize (which two-thirds of taxpayers can't) and your miscellaneous itemized deductions must be more than 2% of your adjusted gross income.
Unless all your investments have been real stinkers and you expect to die soon, it's kind of hard to imagine a scenario in which liquidating your Roths makes any sense. Even if your Roths are currently worth less than your contributions, you probably have at least a couple of decades for the value of your accounts to recover.
Given the powerful advantages of a Roth -- tax free income, no distribution requirements, the ability to leave the money to your heirs -- you shouldn't throw yours away lightly.
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