What Happens When You Sell For a Loss in an IRA?
Your experience may have taught you to maximize losses in a taxable account. But for investments held within an IRA, understanding its tax rules can be complex and can require extra patience when harvesting losses.
IRAs offer many of the same investments available through brokerage accounts, including stocks, bonds, mutual funds and ETFs. Under IRS law’s wash-sale rule, selling for a loss in an IRA and then purchasing back within a short window are prohibited from happening.
Importantly, investment losses cannot be deducted inside an IRA due to tax implications imposed when they leave a taxable account; but not so in an IRA.
Reason being, there is a rule known as the wash sale rule which prohibits you from deducting losses when selling and then repurchasing stock within 30 days into an IRA, meaning any disallowed losses must be added onto the cost of new replacement shares instead of deducted as losses.
Once again, even when avoiding the wash-sale rule, the IRS does not show much mercy when it comes to deducting losses on stocks held within your IRA. Losses on stock only qualify for deduction as miscellaneous itemized deductions on Schedule A subject to the 2% adjusted gross income limitation.
Wash Sale Rule
Tax-loss harvesting in taxable accounts may be straightforward, but retirement accounts come with additional rules to be mindful of before engaging in transactions that might be considered “wash sales”. According to the Internal Revenue Service’s definition, this means selling an investment at a loss before or after 30 days (Source: U.S. Internal Revenue Service Publication 550 2022.)
Harry could make use of the wash-sale rule by selling his shares of AVGO in his IRA and immediately purchasing equal number in non-qualified accounts, violating it in the process and leaving himself on the hook for capital gains taxes–an expensive and ineffective strategy. Or, alternatively, he could preserve his IRA position in the stock and use it for charitable giving or meeting required minimum distributions after turning 73–this strategy may also leave him ahead in the long run but only by a slight amount.
IRS rules regarding investment losses in IRAs are stringent; to claim one on an IRA stock sale, all balance must be withdrawn including traditional, SEP and SIMPLE accounts as well as Roth ones – including Roth ones! Also, itemize deductions using Schedule A for any deductions over 2% of adjusted gross income.
Earnings, dividends and capital gains accumulate tax-deferred until distributions are made from an IRA plan. Once withdraws are taken out as usual income, any early withdrawal penalties could apply; to minimize this tax hit by age 59 1/2 withdrawals early withdrawal penalties you can use tax loss harvesting which involves selling losing investments within your IRA to offset gains in other accounts; but remember the wash-sale rule prohibits you from doing this more than twice within a 61 day window! For further assistance speak to a tax professional
Rebalancing an IRA should be part of every investor’s routine and it can help maintain your original asset allocation plan, while relieving yourself of emotional influences when making decisions in volatile markets.
But if you want to use IRA losses for tax purposes, the process can be more complex than you initially realize. First of all, when declaring losses you should keep in mind that only losses can be recognized when their aggregate cost basis (traditional, SEP and SIMPLE IRAs) exceeds their current values.
Tax-loss selling may make sense for those with taxable accounts that don’t meet the IRS’ 2% miscellaneous itemized deduction threshold, while it might not be feasible for many who have substantial underwater IRA balances accumulated over time. But this doesn’t mean there aren’t other solutions; your financial advisor can help identify some possibilities.