Retirement Weekly: Now is a good time to account for investment losses

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Q.: Hi Dan,

I read with interest your July 2017 article on how a loss carry-over applies to offset current gains, but only partially to offset taxes otherwise due on conversions to Roth IRAs, but I now wonder if a current year’s stock loss could be used to offset dollar-for-dollar a current year’s conversion. Can you help me? 

A.: 2017. That might qualify as a golden oldie at this point. With so many asset values down in 2022, this is a good time for a review about accounting for losses.

There have been no changes to how capital losses are handled since 2017. To take a loss, you must sell the asset for less than its “basis” at a time that is more than 30 days before or after purchasing the asset. If a purchase occurs within that 60-day window, the loss is disallowed due to the wash sale rules. In other words, if you want to use the loss on your tax return, wait at least 30 days after the purchase date and do not buy it back within 30 days of the sale.

Wash sale rules apply across different account types and financial institutions. The sale of a security at a loss in your taxable account at one institution and the next day’s purchase of the same or a “substantially identical” security in your Roth IRA at another institution is technically a wash sale. The definition of “substantially identical” has been debated for years but a description and the wash sale rules are on page 56 of Publication 550. Also, note that reinvested dividends are technically a purchase of additional shares, so such transactions are can trigger a wash sale issue with respect to those shares.

Allowable losses must first be used to offset gains realized during the year the loss was incurred. If that results in a net loss, then the loss can offset other income like that from a Roth conversion but — only up to a maximum of $3,000. If the net loss is greater than $3,000, the excess carries forward to the following tax year. During that next year, it is again used first toward offsetting gains in that year, then other income but again, only up to $3,000.

So, say you make just two transactions in a taxable account resulting in a $20,000 long term gain on the sale of one security and a $15,000 loss on the sale of another. In addition, there is a Roth conversion of $30,000 of pretax IRA money. There is a net gain of $5,000 ($20,000 gain less the $15,000 loss) taxed at the long-term capital gain rate and $30,000 taxable as ordinary income that will be reported on your tax return.

But if the gain were only $5,000 instead of $20,000, there would be a net loss of $10,000 ($5,000 — $15,000 = ($10,000)). Only $3,000 of that loss flows through to the tax return and is reported as a loss. The $30,000 conversion is still reported as part of line 4b and the ($3,000) will appear on line 7, “Capital gain or (loss)”. When it is all added up, the net is $27,000 taxable as ordinary income.

The remaining $7,000 of losses carries forward into the following year to be used against that year’s gains. If no gains are incurred that year, $3,000 of the loss carryforward appears, on Line 7 and the remaining $4,000 carries forward to the next year. Capital loss carryforwards can keep on like that until all used up or the taxpayer dies. Upon death, a surviving spouse may be able to use some of the losses going forward but I will save how that works for another time.

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line. 

Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.

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