Life and Death Planning for Retirement Benefits

Chapter 8: Investment Issues; Plan Types

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It is the IRS position that the individual actually must close out all his Roth IRAs (or all his traditional IRAs), in order to claim a loss on the Roth IRAs (or traditional IRAs), because (according to the IRS) all Roth IRAs are treated as a single account for income tax purposes (and all traditional IRAs are treated as a single account for income tax purposes). Notice 89 -25, A-7, 1989-1 CB 662. Here’s how the IRS gets there: The applicable Code sections ( § 408(d)(2)(A) ; § 408A(a) ; § 408A(d)(4)(A) ) require aggregation for purposes of applying § 72, the section that governs income taxation of IRA distributions ( ¶ 2.1.01 ). Only by applying § 72 can you determine the individual’s basis (investment in the contract) with respect to his IRAs or Roth IRAs. Therefore without applying § 72 you cannot determine the amount of the loss that will be deductible. Therefore the aggregation rule applies in obtaining a deductible loss—even though the ultimate deduction is under § 165 (see “C” below) not under § 72 . For which IRAs must (and may not) be aggregated for purposes of calculating and realizing a loss, see: ¶ 5.2.03 (B) for Roth IRAs, ¶ 2.2.08 (F) for traditional IRAs, and ¶ 2.2.07 for inherited IRAs. B. Loss equals basis minus proceeds. The amount of the loss is limited to the participant’s basis in the Roth IRAs (or traditional IRAs as the case may be). Reg. § 1.165-1(c)(1). A participant may or may not have basis in a traditional IRA; see ¶ 2.2.06 – ¶ 2.2.07 regarding how to determine basis in a traditional IRA. Though unusual, it is possible for a participant’s account value to be worth less than this basis. A built-in loss is less unusual with a Roth IRA. The participant typically has a relatively high basis in his Roth IRA, especially shortly after creating it, because he has paid income tax on all his contributions to the account. If the Roth IRA subsequently declines in value, the participant now has a built-in loss in his account. See ¶ 5.2.06 and ¶ 5.7.08 (D) regarding how to determine basis in a Roth IRA. C. How to deduct the loss. Everyone agrees that IRA losses are deductible in some fashion, under some Code section. However, the authority for exactly how such losses are to be deducted is scant to nonexistent. The problem is that IRA distributions are generally taxed under § 72; see ¶ 2.1.01 . But § 72 has no provision for a loss. See Rev. Rul. 2009-13, 2009- 21 IRB 1029, and PLR 2009-45032. One possible source for the deductibility of IRA losses is § 165: An individual is allowed an income tax deduction for a loss “incurred in any transaction entered into for profit.” § 165(a), (c)(2). Another is § 212, expenses incurred for production of income (see ¶ 8.1.04 (B)). IRS Publication 529 (“Miscellaneous Deductions”; 2009 ed., p. 9) lists IRA losses among the long list of “items” that are deductible as expenses paid either “To produce or collect income that must be included in your gross income” or “To manage, conserve, or maintain property held for producing such income.” Those would be § 212 deductions. IRS Publication 590 (“IRAs”; 2009 ed., p. 40) says only that the loss is deductible as a miscellaneous itemized deduction, subject to § 67 (miscellaneous itemized deductions are deductible only to the extent the total of such deductions exceeds 2% of adjusted gross income), and to the reduction of itemized deductions that is applicable, through 2009 and after 2012, to high-income individuals under § 68 .