What Happens When You Sell for a Loss in an IRA?

Watching your IRA investments lose value is disconcerting, but before panicking and unloading them all at once, make sure that you understand the tax rules before doing anything drastic to limit losses.

Typically, investment losses in an IRA cannot be deducted because their contents are already subject to tax when withdrawn; however, under the Tax Cuts and Jobs Act (TCJA), miscellaneous itemized deductions including loss deductions were disallowed, which includes deductions related to an IRA investment loss.

Loss Deduction

Prior to 2018, you could deduct losses on IRA investments as miscellaneous itemized deductions reported on Schedule A as long as their loss exceeded 2% of your adjusted gross income. Unfortunately, due to Tax Cuts and Jobs Act (TCJA), this tax benefit has now been eliminated.

IRAs offer tax-deferred investment growth. That means any gains aren’t subject to tax until withdrawal – typically during retirement.

But what happens if your investments lose value? As an IRA owner, that could be a worry when trading stocks that involve master limited partnerships and other pass-through entities that impose different tax regulations than usual. But there’s an easy solution: move your IRA funds from one custodian to the other through direct trustee-to-trustee transfer.

Wash-Sale Rule

Tax-loss harvesting can be a challenging strategy for IRA investors, however. According to IRS rules, you cannot claim losses on an investment if within 61 days before or after sale you buy something with “substantially identical characteristics”. This rule was designed to deter bad faith investors from profiting from temporary dips in value before purchasing back at higher cost basis and increasing future taxes due on gains.

So it is essential that when selling in your IRA, strict netting rules are strictly observed and that you use a diverse portfolio. Although the Tax Cuts and Jobs Act has eliminated miscellaneous itemized deductions for investments held within an IRA account, including losses, it does not impact the wash-sale rule; because its rules can be complex it’s wise to consult your financial planner in finding the optimal strategy that fits both your long-term investing goals and account structure. A tax loss harvesting plan meeting IRS criteria can reduce both future tax bills significantly

Rebalancing Your Portfolio

Rebalancing your portfolio helps ensure its investment mix matches up with your goals and risk tolerance, by selling any assets that have appreciated and purchasing new ones to bring it back into balance. While this may trigger capital gains taxes, using tax loss harvesting could mitigate some unwanted losses according to Watson.

As part of your investment routine, it’s advisable to review your portfolio on an annual basis at least. If your retirement goals or timing shift suddenly, however, rebalancing could become necessary more frequently.

Rebalancing your portfolio depends on both its type and length of ownership. Rebalancing in an IRA or tax-advantaged retirement accounts won’t incur capital gains taxes; however, selling assets through a taxable brokerage account might incur them; for that reason it is wise to consult a tax professional prior to making changes in your portfolio.

Taxes

Tax implications of an IRA loss vary based on its investment type and account rules. For instance, if you invest in forbidden assets like precious metals or real estate through your IRA account, earnings will be taxed as unrelated business taxable income (UBTI), meaning they’re subject to tax in both years they were earned and when distributed from your account.

Prior to the Tax Cuts and Job Act (TCJA), itemized deductions for IRA losses that exceeded 2% of your adjusted gross income were only allowed if they were itemized on Schedule A and itemized deductions were limited; but now that the TCJA has reduced many miscellaneous itemized deductions this tax benefit has become only accessible for a select few taxpayers.

Reinvesting proceeds of an IRA loss within its plan is typically preferable as this reduces tax impact at withdrawal time, when tax rates may often be significantly less than their underlying cost basis of investments.


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