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TAX ALERT: Recognition of Losses in Investment Plans

Post a Comment October 19, 2009 – 12:56 pm | Post Link |  Print This Post |

Taxpayers who have suffered substantial investment losses in their 529 plan accounts or IRA accounts may be able to recognize losses if the accounts are liquidated.

Recognition of losses in 529 plans

Liquidation of a 529 plan account by the owner of the account (usually a parent or grandparent) can result in a taxable loss if investment losses have reduced the value of the account below the basis in the account (original contributions less any prior withdrawals of contributions).

A loss can be deducted on Schedule A subject to the 2% of AGI limit and can only be taken if an entire account is liquidated (but the owner can have other 529 plan accounts that do not have to be liquidated).  The owner can reinvest the proceeds in another 529 plan account but has to wait 60 days before doing so.  Note also that losses from one 529 plan account that is liquidated must be netted with any income from any other 529 plans that are liquidated in that tax year before any losses are allowed.

One major drawback is that the losses are subject to 2% of AGI.  Also individuals subject to AMT will not receive any tax benefits from the loss.  If the original contributions were deductible for state tax purposes, then the liquidation may result in a smaller loss for state tax purposes or perhaps trigger a state income tax liability.  Finally, since a transfer to a 529 plan is deemed a completed gift, if an owner wishes to re-invest in another 529 plan after 60 days, this would almost certainly be viewed as another gift. Depending upon the owner’s circumstances and the amounts involved, this may or may not have gift tax consequences that need to be considered.  See IRS ANN. 2008-17.Recognition of losses in IRA accounts

Liquidation of losses in traditional IRA (with non-deductible contributions) or Roth IRA accounts can also result in losses if the basis in the accounts is less than the current value and the accounts are liquidated.  Any losses are deductible on Schedule A subject to 2% of AGI.  A taxpayer cannot just liquidate one IRA account and take losses, rather all amounts in all accounts of the same type (i.e. all traditional IRA accounts or all Roth IRA accounts) must be distributed before any losses are allowed (this differs from 529 plan accounts where each account is treated independently).  Annual contribution limits on IRAs are far less generous than for 529 plans, so their account balances cannot be rebuilt as quickly.