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Should I sell at a loss to get the tax benefit?

Posted by Andrew Chan  November 13, 2008 09:45 AM

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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 dollars 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 dollars of net capital losses on your tax return. Any net losses above $3,000 dollars 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 dollars for those who are under age 50 and $6,000 dollars 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)

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