Can I Deduct IRA Losses on Federal Taxes?
Through your Individual Retirement Account (IRA), it is possible to accumulate hundreds of thousands of dollars toward your retirement savings. There are also financial risks that may translate into IRA losses. Contrary to regular taxable accounts, IRA losses cannot be deducted from your taxable income. As an investor, you should familiarize yourself with the tax breaks that are available for IRAs before integrating these vehicles within your financial plan.
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Types
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IRAs can be categorized into traditional and Roth IRA accounts. Contributions into a traditional IRA are tax deductible, while Roth IRA contributions are made with after-tax money.
Upon withdrawal, your traditional IRA balance is generally taxed as ordinary income. Alternatively, Roth IRAs allow for tax-free withdrawals because the original Roth IRA contributions have already been taxed. Be advised that you will be subject to a 10 percent penalty tax if you choose to withdraw money before age 59 1/2.
Features
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IRAs allow for tax deferral. This means that capital gains and losses carry no tax ramifications, as they occur within your account. Investment income, such as dividend and interest payments that you collect within your IRA, also bypasses taxes. For a traditional IRA, the balance of your contributions alongside investment gains and losses will all be taxed as ordinary income upon withdrawal.
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Considerations
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Taxable brokerage accounts do allow for deductible realized capital losses. You realize a capital loss when you sell an investment at a loss. To write off realized capital losses, you must learn to calculate the cost basis, which includes brokerage commissions.
For example, you may pay $7 in commissions for each online trade. If you buy 10 shares of Stock Z at $100, your cost basis would then be $1,007 (10 x $100 = $1,000 + $7 = $1,007). Later that year, you may sell Stock Z at $80 -- for a loss. Proceeds from the sale would then be $793 (10 x $80 = $800 - $7 = $793). You would then be able to deduct $210 ($1,007 - $793) in losses from your taxable income.
Warning
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When making investment decisions, your ultimate goal is to make the most money possible for the least amount of risk. An effective balance of risk versus reward does not always translate into minimizing your tax bill. For example, you should not open up a taxable brokerage account and trade for poorly performing shares of stock for the sole purpose of writing off realized capital losses from your taxable income.
Strategy
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As part of your overall financial plan, you may combine a taxable brokerage account with an IRA. The taxable account allows for flexibility because you can withdraw money from the account at any time without penalty. Roth IRAs are more ideal for young savers, who expect to retire within a higher tax bracket and will therefore benefit most from tax-free withdrawals. As a high earner, however, you may prefer to make tax-deductible contributions to a traditional IRA to save money on your current tax bill.
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