When Your Investment Losses Really Aren’t (at Least in the Eyes of the IRS)
Your investments tanked in 2008. So does that mean you get a tax deduction?
There’s nothing to report on your tax return if your investment lives — like most everyone’s does — in a 401(k) or an IRA. These are special no-taxes zones, where you can buy and sell securities and mutual funds without having to report the capital gains and losses on your tax return. When you eventually take your money out, however, you’ll have to pay income taxes on some or all of it (unless it’s coming from a Roth IRA.)
But what about the investments you own outside of your retirement accounts?
Let’s say your 200 shares of the Bank of What Was I Thinking have fallen by 50 percent.
You can’t deduct your loss, however, if you haven’t sold those shares. Until you sell, you have what’s known as a “paper loss,” not an actual loss.
Now then, even if you sold your shares after watching them lose half their value, you still might not get to claim a loss. Let’s say you bought the shares at $50 each, they climbed to $140, then fell to $70 at which point you decided to sell them. However, you don’t have a loss. You have a gain of $20 per share. And you need to report that on your tax return.
Here’s another puzzler. You might have a taxable gain even if you didn’t sell any of your investments. How is that possible?
Because a mutual fund you own sold some stocks and bonds it had in its portfolio. Here’s what happens when the markets climb steeply then fall precipitously, as they did in recent months:
When the markets were booming, your mutual fund held stocks that had shot up value. And when the markets fell, some investors decided to bail. The managers of your mutual fund had to pay those investors, so the managers sold highly appreciated stocks to raise the cash. That generated capital gains for the mutual fund, which are passed on to you as capital gain distributions.
Unless, of course, your mutual fund is in your retirement account. You don’t have to report your “gain” to the IRS.
For more information on about taxes and your investments, read Capital Gains and Losses.