Q.: Hi Dan,
I read with interest your July 2017 article on how a loss carryover applies to offset current gains, but only partially to offset taxes otherwise owed on Roth IRA conversions, but now wonder if the current year inventory loss could be used to offset current year dollar-for-dollar conversion. Can you help me?
A.: 2017. This could be called golden oldie at this point. With so many asset values falling in 2022, now is a good time for a review of accounting for losses.
There have been no changes to the way capital losses are handled since 2017. To incur a loss, you must sell the asset for less than its “basis” more than 30 days before or after the purchase of the asset. If a purchase occurs within this 60 day window, the loss is disallowed due to 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 don’t buy it back within 30 days of the sale.
Wash sale rules apply to different types of accounts and financial institutions. Selling a security at a loss in your taxable account at one institution and buying the same or “substantially identical” security in your Roth IRA at another institution the next day is technically a wash sale. The definition of “substantially identical” has been debated for years, but a description and fictitious selling rules can be found on page 56 of Post 550. Also note that reinvested dividends are technically a purchase of additional shares, so such transactions may trigger a wash sale issue regarding those shares.
Allowable losses must first be used to offset gains made in the year the loss was incurred. If it results in a net loss, 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 is carried forward to the next tax year. In the following year, it is used again first to offset that year’s earnings, then other income, but again, only up to $3,000.
So let’s say you only make two trades in a taxable account, resulting in a long-term gain of $20,000 on the sale of one security and a loss of $15,000 on the sale of another. Plus, there’s a Roth conversion of $30,000 of pre-tax IRA money. There is a net gain of $5,000 ($20,000 gain less $15,000 loss) taxed at the long-term capital gain rate and $30,000 taxable as ordinary income that will be reported on your income tax return. income.
But if the gain was 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 this loss is paid into the tax return and reported as a loss. The conversion of $30,000 is always reported on line 4b and the ($3,000) will appear on line 7, “Capital gain or (loss)”. When everything is added up, the net amount is $27,000 taxable as ordinary income.
The remaining $7,000 of losses are carried forward to the next year to be used against that year’s winnings. If no gain is incurred that year, $3,000 of the loss carried forward appears on line 7 and the remaining $4,000 is carried forward to the following year. Capital loss carryforwards can continue until they are exhausted or the taxpayer dies. Upon death, a surviving spouse may be able to use some of the losses in the future, but I’ll save how that works for another time.
If you have a question for Dan, please. send him an e-mail with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving customers nationwide from offices in Orlando, Melbourne and Tampa Florida. His comments are for informational purposes only and cannot replace personalized advice. Consult your advisor to find out what is best for you. Some questions from readers are edited to facilitate the presentation of the topic.