Watching your IRA investments fluctuate can be stressful. But jumping too quickly to sell them might actually do more harm than good.
Investors with an IRA may take advantage of investment losses by harvesting them; however, doing so comes with certain restrictions and tax deductions may help offset gains within their account and lower overall tax liabilities.
1. You can’t deduct the loss
At present, losses in individual retirement accounts (IRAs and Roth IRAs) aren’t tax deductible, thanks to the Tax Cuts and Jobs Act (TCJA), which eliminated miscellaneous itemized deductions, such as those related to investments held within an IRA. But this may change at some point; so take note of any future changes.
Financially speaking, selling at a loss often doesn’t make financial sense when other IRA investments offer enough basis to cover its cost. Instead, let your losses accumulate until they can be offset by future gains in your accounts.
Selling at a loss can lead to investment regret, with panicked sales of your IRA investments setting back long-term returns for years. Instead, work with a financial advisor who can develop a tax strategy and maximize your IRA investments. Online tax calculators can give insights into potential tax savings through loss harvesting; additionally they help analyze your individual financial situation and plan accordingly.
2. You can’t reinvest the loss
Retirement plans provide investors with an additional tax advantage by deferring taxes until distributions from their account. This tax-deferral feature enables investors to build wealth more rapidly than they might in non-tax advantaged brokerage accounts.
Utilizing investment losses to offset gains is a straightforward practice in taxable accounts, but can be more complicated for investments held within an IRA due to the wash-sale rule which prohibits reinvesting an identical security after selling it at a loss.
Keep meticulous records of original cost, sale proceeds and transaction costs of the investments you own within an IRA to reap investment losses for tax deduction purposes and offset capital gains within it or lower your taxable income.
3. You can’t offset gains
Prior to the Tax Cuts and Job Act (TCJA), investors who made losses when selling investments from tax-sheltered accounts were able to deduct those losses from their taxes by itemizing and reporting these losses on Schedule A of their return – it was the only way for investors who held IRA or 401(k) holdings to do so.
Investors still can reap losses in their IRA accounts, but are unable to offset gains made from sales with losses harvested in those accounts – making this strategy much less appealing for those with significant accumulated IRA balances.
In such cases, it may be wise to devise a withdrawal plan rather than attempt to reinvest their assets. For instance, those with Roth and nondeductible IRAs can withdraw first from one before proceeding to withdraw from both (or transfer their balance into taxable accounts if they fail to meet the 10% early withdrawal penalty).
Investors should keep in mind that the IRS’s wash-sale rule prohibits purchasing an investment within 30 days after selling it at a loss, making keeping detailed records essential.
4. You can’t avoid penalties
Typically, any money withdrawn from an IRA will be subject to ordinary income tax and a 10% penalty if taken prior to age 59 1/2. But distributions from traditional or Roth IRAs may be used instead for unreimbursed medical expenses that exceed 7.5% of your AGI or for purchasing your first home. To do this, take appropriate action as soon as necessary in order to avoid penalties.
If you make an IRA purchase for a loss within 30 days before or after selling shares for a loss and then buy back substantially identical investments within this same timeframe, the wash-sale rule kicks in and you cannot deduct your loss because the purchase must have been made by someone different than who sold them. It is crucial to keep this rule in mind as it limits tax loss harvesting in retirement accounts significantly and without detailed records of original investment cost and sale proceeds, effective tax deductions cannot be generated.
