When the income isn’t taxable, the losses aren’t deductible. Some stockbrokers like to buy publicly-traded natural resource partnerships as IRA investments. I dislike them because those partnerships can trigger Unrelated Business Income Tax in an otherwise tax-exempt IRA.
An attorney in Virginia illustrated another problem with IRA partnership investments in Tax Court yesterday. From the opinion by Judge Haines:
Petitioner maintained a traditional IRA during 2009 and used it to buy and sell various securities, including shares of two master limited partnerships that were involved in the oil and gas pipeline and storage industry–Atlas Pipeline Partners, L.P. (Atlas), and Crosstex Energy, L.P. (Crosstex). Petitioner received a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., from Atlas reporting a $66,075 ordinary business loss for 2009. The Schedule K-1 indicated “Trad IRA VFTC as Custodian” and stated that the partner was an “IRA/SEP/KEOGH”. Petitioner reported this loss on the Schedule E, Supplemental Income and Loss, attached to his 2009 Form 1040, U.S. Individual Income Tax Return. Petitioner received a Schedule K-1 from Crosstex reporting a $22,793 ordinary business loss for 2009 and stating that the partner was an “IRA/SEP/KEOGH”. Petitioner also reported this loss on the Schedule E attached to his 2009 Form 1040.
This would have been a remarkable result, if it worked. Individual owners of publicly-traded partnerships have their K-1 losses automatically disallowed under the passive loss rules. Unlike other passive losses, those from publicly-traded partnerships can’t offset other passive income; they can only offset future income from the same partnership, until the partnership is sold.
Within an IRA, though, the losses are never allowed. The tax law allows IRAs to earn income without current tax. The idea is to help taxpayers accumulate funds for retirement. Any tax is deferred until you withdraw funds from the IRA. The downside of this is that losses are also deferred. The only way to deduct a loss from IRA investments is to completely close out the IRA. That only works if you have made non-deductible contributions to the IRA, giving you basis. From IRS.gov, Publication 590b:
If you have a loss on your traditional IRA investment, you can recognize (include) the loss on your income tax return, but only when all the amounts in all your traditional IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis, if any.
Your basis is the total amount of the nondeductible contributions in your traditional IRAs.
You claim the loss as a miscellaneous itemized deduction, subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions on Schedule A (Form 1040). Any such losses are added back to taxable income for purposes of calculating the alternative minimum tax.
Our attorney was having none of that. From the Tax Court:
Petitioner argues, in part, that an IRA has “all of the attributes of a grantor trust and is therefore a pass through entity which makes all items of income, deduction and credit treated as belonging * * * [to him] and reportable on * * * [his] individual tax return”.
I’m sure he would have taken that same principled position if those K-1s generated a bunch of taxable income.
Petitioner advances various tax policy arguments which he believes support this position. For example, he contends that restricting an IRA holder’s ability to deduct a loss that occurs when an investment held by the IRA is sold thwarts congressional intent to encourage individuals to save for retirement. He also claims that requiring retirees to completely liquidate their IRAs in order to recognize a deductible loss is “unreasonable, arbitrary, capricious and completely unworkable for savers dependent upon IRA/SEP income for their retirement.”
Unfortunately, heads-I-win, tails-you-lose only works for the IRS. Again from the Tax Court:
While petitioner may not agree with the way the law is written and may have reasons that he believes support changing the law, we cannot do that for him.
Silly lawyer. Only the Supreme Court can rewrite tax law.
The Moral: IRA investments in partnerships can give you the worst of both worlds. You can make a tax-exempt entity taxable (or much worse, if you invest in the wrong partnership), but your losses are almost never useful.
Cite: Fish, T.C. Memo 2015-176.
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