By Andrew Keshner
Different accounts have different tax rules, and Tax Guy is here to sort it out
Dear Tax Guy:
My mother passed away in first quarter 2021, leaving me a designated beneficiary brokerage account and an IRA account.
The total amount of these accounts invested in stocks and ETFs was at that time $150,000. Since then, due to the market (or my poor management), those accounts are totaling around $122,000.
Can I liquidate those two accounts and take a tax write-off?
Mulling next move
Dear Mulling,
My condolences about your mother. Now, let's make the best of the situation.
There's a tax way to think about the approximate $28,000 loss gnawing at you. If you want to liquidate these inherited accounts, the tax code might help -- but a nasty tax bite could be lurking if you aren't aware.
There's also an investing way to think about these accounts. Be easy on yourself about the losses, by the way. 2022 was tough for lots of portfolios and there's still six months to see the full extent of 2023's rebound. But if you close these accounts now, what's the plan for where the money goes next?
Let's start by distinguishing the different IRS rules at play with your inherited brokerage account and your inherited IRA.
There was a time when you could have deducted the losses on that inherited IRA, said Luis Rosa, founder of Build a Better Financial Future, where he he offers investment management and tax preparation services.
That would've happened by itemizing your deductions and taking advantage of a miscellaneous deduction, he said.
That changed with the 2017 Tax Cuts and Jobs Act, a sweeping tax code overhaul that included major changes for individual filers through 2025.
The law nearly doubled the standard deduction while reducing the ways people could itemize their deductions. A number of miscellaneous itemized deductions were temporarily repealed.
The "loss on traditional IRAs or Roth IRAs, when all amounts have been distributed to you," was one example, the IRS said.
"Unfortunately, any losses in an IRA are gone and there's no tax benefit to them," Rosa said.
In the current set of rules, if you cashed out the inherited IRA, "all that would be considered taxable income as well, to add insult to injury," he added. More specifically, Rosa said the distribution would count as ordinary income, which doesn't get the preferential rates that apply to long term capital gains.
A sudden one-year income spike from the closed-out IRA could potentially push you into a higher tax bracket and have you facing a bigger tax bill that year, Rosa noted.
A better tactic would be gradually siphoning the account's proceeds over the years to avoid a sharp income tax bill increase, he said. Beneficiaries have a decade to liquidate an inherited IRA The time to close out the account finishes at the end of the 10th year after the death of the IRA owner, Vanguard notes
Then there's the brokerage account. Here, capital gains and loss rules are the key.
The losses from this account will offset any long-term capital gains you've taken elsewhere, Rosa said. If there's still more losses after the offset, you can use them to reduce your income by up to $3,000 The rest of the losses can be carried forward to future tax years.
You could liquidate the IRA account in small gulps and you could sell the brokerage holdings and apply the capital losses there. You could also sell at a loss in small increments with the brokerage account too. Or you could play the waiting game and see if the investments turn for the better.
However you play it, there's the next question: What's next for the money?
Do you reinvest it back in the stock market?
If so, beware of an IRS wash sale rule that will disallow a capital loss if the seller buys the same, or nearly the same, security just before or just after the sale. The wash sale rule applies to the 30-day window before the sale and the 30-day period afterwards.
That's a technical matter, but the general point is have a plan as you move on."If you are going to sell, know where it's going," said Scott Bishop, partner and managing director of Presidio Wealth Partners.
If newly-purchased securities are going in those existing accounts, Bishop said it matters what sorts of investments are inside those accounts.
Remember, when the IRA money comes out, it counts as ordinary income. So if you put a fast-appreciating asset like a stock in the account, it will balloon the income tax liability when the money eventually comes out, Bishop said. (And again, you have a 10-year deadline to clear out the IRA.)
A better move could be putting assets with smaller returns -- like bonds -- in the inherited IRA because smaller returns will translate to a smaller income tax hit at distribution, he said. Save any new stock investments for the brokerage account.
That's where the capital gains rates can save you tax dollars on high-flying investments, Bishop noted. "You want to think of the tax nature about what you are doing," he said.
But most of all, you want to think about what you are doing in the broadest sense. "Don't sell until you have a plan to buy," Bishop said.
Cashing out the holdings and then reacting to market swings is a strategy that's asking for trouble.
"The emotional biases we have make it difficult to sit with cash. .... The market has a great way of making us look foolish," Bishop said.
Got a tax question? Write me at: akeshner@marketwatch.com
Thanks for reading. I want to help you think more broadly about the issues that affect your taxes. I'm not offering tax advice, just an attempt to look at what the swirl of tax rules and economic conditions could mean for your wallet.
I'm here for the reader who faces their taxes with an air of resignation. You're just not that into taxes, I get it. I was once that guy. Underneath the jargon, think of your taxes like a maze -- with money at the end. Or a trap that you need to avoid.
-Andrew Keshner
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07-13-23 1707ET
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