Tax-Loss Harvesting and Selling for a Loss in an IRA
Some investors utilize tax-loss harvesting as a strategy for extracting maximum benefits from losing investments, although you’re only eligible to claim write-offs in a taxable brokerage account.
Under the wash sale rule, selling for a loss in an IRA account and then purchasing back within 30 days would constitute a breach. These accounts are treated similarly to traditional brokerage accounts in this regard.
Loss Deduction
When selling stocks or investments at a loss in a taxable brokerage account, the IRS allows you to use those losses against gains on your tax return for that year. Unfortunately, however, that deduction doesn’t apply when losses occur on assets in an individual retirement account.
Investors with Individual Retirement Arrangements (IRAs) can still lose money through excessive risk-taking or mismanaging their asset allocation, and taking distributions too soon.
Checking your IRA portfolio regularly – not every day or even week – and withdrawing according to its basis (after-tax contributions made) can help prevent unnecessary losses. In the past, taxpayers could deduct losses from an IRA against other itemized deductions allowed, but this loophole was closed with the Tax Cuts and Jobs Act of 2017. This change aims to prevent taxpayers from cashing out traditional and Roth IRA accounts in order to take advantage of tax losses by cashing them out instead.
Wash Sale Rules
One of the rules investors must keep in mind when selling assets at a loss is that if they purchase “substantially identical” assets in an IRA within 30 days before or after selling, this may cause their loss deduction to be forfeited.
Some traders employ a technique known as tax-loss harvesting to defer taxes on losses incurred from trading poorly performing stocks by selling and then immediately purchasing them back in an IRA; this practice, however, triggers a wash sale which prevents deduction of loss deduction. The IRS has since determined this strategy should no longer be employed.
The IRS holds that purchasing assets through your IRA does not increase its basis since no capital gains tax is paid on distributions from an IRA. This is unfortunate in down markets when you may want to capture some of that pain by selling shares in your taxable account and purchasing similar ones in your IRA account.
Taxes
Time passes and investments may decrease in value; but that shouldn’t be used as an excuse to sell off losing assets from your individual retirement account, particularly traditional or Roth IRAs where this can be costly in terms of taxes.
Before the Tax Cuts and Job Act (TCJA), losses on IRA investments were eligible for deduction as miscellaneous itemized deductions on Schedule A of Form 1040; however, their deduction was limited to 2% of your adjusted gross income.
Investors seeking to use loss selling in their IRAs would do well to consider both current and projected tax rates and income levels before embarking on loss selling strategies. By doing this, they could redeem non-IRA stocks and mutual fund shares to generate a net capital loss that is fully deductible against ordinary income while funding their current year IRA contributions. This strategy works particularly well for those who have amassed small amounts of IRA-based basis that surpass their deductible contributions as well as those making nondeductible IRA contributions or who don’t anticipate exceeding 2% itemized deduction threshold.
Rebalancing
Rebalancing an IRA regularly is an effective way to ensure that it continues to meet your original investment goals and strategy. Over time, investment mix can easily drift away from what was originally set. For instance, if your original portfolio consisted of 60% stocks and 40% bonds initially but has become overweighted in stocks over time – in such instances selling some stocks can help bring it back in line with desired percentage allocation.
Rebalancing within retirement accounts typically doesn’t trigger capital gains taxes because any assets sold don’t get replaced immediately with another asset purchase; however, in taxable brokerage accounts tolerance rebalancing may incur tax liabilities. It is best to discuss its pros and cons with your financial advisor to find what best fits you.
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