Pondering the tax impact of selling a fund after a loss

From the "Managing Your Money" personal finance blog on www.boston.com/business:

I have a small portfolio of mutual funds that have lost a good 33 percent during this crisis. If I have my broker sell $5,000 of that portfolio and contribute it to my Roth IRA, would I be able to claim a loss for my 2008 taxes? Then, when the market gains, would those gains be taxable in the Roth?

Roth IRAs are great retirement vehicles but they can be confusing. Your question does not specifically mention if your portfolio of mutual funds is in a taxable account or in a retirement account so I am reading into your question a little and assuming that it is in a taxable account.

Generally, if you sell your mutual funds at a loss, you will be able to use that loss to reduce any taxable gains realized in that same year. If you do not have any gains during that year or if your losses exceed your gains, which may be more likely given the state of the financial markets this year, you can claim up to $3,000 of net capital losses on your tax return. Any net losses above $3,000 can be carried forward to your 2009 tax return.

If you subsequently use some of the proceeds from the sale of your mutual funds and make a contribution to a Roth IRA, the money contributed and any future earnings on those contributions are tax free when you make qualified distributions/withdrawals from that account. For 2008, the contribution limit is $5,000 for those who are under age 50 and $6,000 for those who are age 50 and over.

The tax benefits of contributing to a Roth IRA are very attractive but keep in mind that:

You need make sure that you are qualified to make contributions to a Roth IRA. On top of that, those who are qualified may not be qualified to make the full contributions amounts noted above. Your Modified Adjusted Gross Income (MAGI) and filing status will dictate if you are qualified and the amount you are eligible to contribute.

Unlike some traditional IRA contributions, contributions to a Roth IRA are not tax deductible.

The amount you can contribute to a Roth IRA may be limited if you already contributed to other IRA accounts this year. The limits noted above are for total contributions to all traditional IRA and Roth IRAs.

Nonqualified distributions/withdrawals from a Roth IRA may be taxable under certain circumstances.

To learn more about Roth IRAs take a look at Publication 590, Individual Retirement Arrangements (IRAs) at the IRS web site. (www.irs.gov)

MORE TO CONTRIBUTE

Good news! The limits on several retirement plans are due to increase in 2009. Be sure you visit your payroll/benefits office to sign up for the maximum contribution permitted.

In 2009, you can contribute $16,500 to your 401(k). That is $1,000 higher than in 2008. If you are age 50 or older, you will be able to contribute $22,000 - an increase of $1,500. These increased limits also apply to 403(b) plans and 457 plans. Unfortunately, there are no increases in the amounts you are able to contribute to traditional and Roth IRAs. Those limits remain at $5,000 and $6,000 if you are age 50 or older.

While these increased limits are good news, there is also some bad "tax news" to throw into the mix. That bad news comes in the form of a higher Social Security wage base in 2009. In 2009, wages up to $106,800 will be subject to 6.2 percent in FICA taxes and 1.45 percent in Medicare taxes. In 2008, the limit was $102,000 so this increased limit causes an extra $298 tax bill for employees.