Q on IRA

[klkemp]

Got a question that a couple of my co-workers were bantering around today. It has to do with an IRA.

If you opened an IRA for lets say $10,000.00 in the past few years it went up in value, but today with the market being what it is, it is now worth $4000.00

If you decide to close you account and take total distribution of the IRA, my understanding is that you would be subject to a 10% penalty for early withdrawal ($400.00), and the remainder of the distribution ($3600.00) would be subject to your standard income tax bracket etc.

Is this correct?

Pretty much everyone agreed that this is correct. However one guy said that you could claim a $6000.00 loss on your taxes since the initial value of your account was $10,000.00 and when you closed it the value was only $4000.00

Someone else said that it wouldn't be treated as a loss but as a miscelaneous deduction subject to the 2% AGI rule.

Does any of this make sense? My head was swimming, but I told them I'd ask input this board might have.

Thanks!

[Broken Arrow]

Hehe. What a good conversation to be in.

If you decide to close you account and take total distribution of the IRA, my understanding is that you would be subject to a 10% penalty

Normally, yes. There are some special exceptions to the rule, and this also assumes that you are not 59.5 years of age or older.

remainder of the distribution ($3600.00) would be subject to your standard income tax bracket etc

True if it's traditional or rollover IRA, but not the Roth.

However one guy said that you could claim a $6000.00 loss on your taxes

Looks like the answer is Yes. The caveat is that the account have to be closed, and the distribution be less than that of your contributions, which is the case here. (Source is at the bottom of page 41 from the link provided.)

Obviously, this also applies to only the traditional or rollover IRA, not the Roth.

Someone else said that it wouldn't be treated as a loss but as a miscelaneous deduction subject to the 2% AGI rule.

Again, the bottom of page 41 from IRS publication 590 should hopefully be enough to answer this part as well. But yeah, this part appears to be correct for the purpose for calculating AMT.

I'd copy and paste the relevant text here, but it's a bit wonky because the PDF file is two pages in one, but the computer only recognizes and highlights it as one page, if that makes any sense.

[noppenbd]

Looks like the answer is Yes. The caveat is that your distribution from all of your traditional or rollover IRA be less than that of your total contributions, which is the case here. (Source is at the bottom of page 41 from the link provided.)
.

I think this is wrong. You can only deduct losses that exceed your basis in your traditional IRA. Basis is only established when you make nondeductible contributions to an IRA. Normal deductible contributions do not add to your basis. So if the $10K was all deductible contributions your basis would be 0. Therefore all of the withdrawal would be taxable. Check the example on page 42 of Pub 590.

[Broken Arrow]

Huh. I don't mind if I am wrong, but isn't that what I had meant by only traditional or rollover IRAs only?

[noppenbd]

I don't think so. Most people make deductible contributions to traditional IRAs. And most contributions to 401ks would be deductible, making the basis in a rollover IRA zero. The main time you would make a nondeductible traditional IRA contribution would be if your income exceeded the cutoff.

[Broken Arrow]

Ah, ok. Thanks for clarifying.