Choose Your IRA Investments Wisely--You Can’t Take a Capital Loss Tax Deduction
Q: I have a tax-deductible individual retirement account that has warrants in it that have become worthless. Because I have managed to accumulate only losses, I would like to close out the account. However, the IRS says I cannot claim any loss. Is this true? Should I just hold onto the account and hope I can generate enough gains to offset the loss?
--K.C.
A: Your situation demonstrates why IRAs should be put in the most secure investments possible. Quite simply, capital loss deductions that apply to other investments are not available for tax-deductible IRAs.
Why? Unlike other investments that are generally made with after-tax dollars, your IRA provides no tax basis against which to claim a loss. Further, the IRS does not allow you to deduct the losses against any personal income, for the same reason.
As to whether you should try to build up that account to offset the loss, only you can decide if you want to stick with what has proved to be a disastrous investment strategy.
But here’s the tax perspective: The assets in IRAs remain tax-deferred until the money is withdrawn, so if you build up the account, you will be taxed on any withdrawals you make from it. It’s not a matter of generating gains to offset losses for tax purposes, but a question of whether you stand a chance of earning back your initial nest egg.
You will be taxed on whatever you withdraw from the account. If you withdraw nothing, you have no tax obligation; if you miraculously build the account up to, say, $100,000, your withdrawals when you make them will count as taxable income.
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Q: I received shares in AT&T; and in Lockheed from my mother when she died in 1981. Because I didn’t pay anything for them, I am wondering how I figure out the cost basis for the stocks when I decide to sell.
--A.M.C.
A: Your cost basis in the shares is their value on your mother’s date of death. All inherited assets are revalued as of the donor’s date of death.
In simple cases--which yours is not--the beneficiary can look up the closing price of the stock on the microfilm of old newspapers at the public library, learn the cost basis, sell the shares and determine the applicable taxes owed. However, both AT&T; and Lockheed have undergone major corporate changes since 1981, and you will have to go beyond simple research.
AT&T;, for example, spun off its regional Bell operating companies in 1984, and shares in each of the Bells were issued to AT&T; shareholders. Four of these Bells have since merged into two sets of two (Pacific Telesis with SBC Communications, the former Southwestern Bell; and Nynex with Bell Atlantic), leaving only five siblings. Before its merger, Pacific Telesis itself spun off its cellular operations into a company now known as AirTouch.
With any luck, your certificates are held by a broker who has kept track of these transactions for you. If not, you’ve got a lot of unraveling ahead.
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Q: I am employed by a large corporation where I earn $35,000 a year and contribute the maximum, 15%, to our company 401(k) plan. I also own my own consulting business, for which I am the only employee. The consulting business generates about $8,000 a year in revenue.
May I open a simplified employee pension individual retirement account, or SEP/IRA, and put $6,000 from my consulting revenue into it?
--J.C.
A: Federal law allows taxpayers to set aside up to $9,500 per year in all types of tax-deferred retirement accounts. (This is the limit for 1996; that for 1997 has not yet been set.)
Based on what you have told us, we’ll assume you are already contributing about $5,250 a year to your 401(k). This would allow you to contribute up to $4,250 from your consulting firm earnings to a SEP/IRA.
By the way, recent federal law permits taxpayers who own outside businesses to put up to 100% of their income from these activities (up to a maximum of $6,000 within the $9,500 total tax-deferred ceiling) into a so-called simple IRA. This contribution is eligible for matching by the employer.
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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to carla.lazzareschi@latimes.com
