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You can't just deduct 401(k) plan investment losses like you would other investment losses on your Form 1040, even if you've sold the investment within the plan or have other investment gains to offset. Generally, you won't be able to take a loss for a 401(k) plan, but when you can, you report the deduction on Schedule A.
To have a tax-deductible loss in your 401(k) plan, you must have a tax basis in the account. The only way to build a basis is by making after-tax contributions to the plan. If you have a traditional 401(k), it's very rare that you'll have made any after-tax contributions. If you have a Roth IRA, all your contributions are after-tax, so your basis will be the amount of money you've contributed. In addition, before you can take a loss for poor investment performance, you must close your 401(k) plan.
The loss amount when you close your 401(k) plan equals your total after-tax contributions minus your total distributions from the account. For example, say you put $30,000 in your Roth 401(k) plan over the years and received $20,000 in distributions: You have a $10,000 loss. If, on the other hand, you contributed that money to a traditional 401(k) plan, those contributions would never have been included in your taxable income so you couldn't deduct losses on that money. Essentially, you already got your deduction when you made the pretax contributions.
Your 401(k) loss -- if you can claim it -- is categorized as a miscellaneous deduction. You can claim such deductions only to the extent their total exceeds 2 percent of adjusted gross income. As a result, the actual amount that is used to lower your taxable income depends in your adjusted gross income. If you have a higher income, you'll get less of a deduction. For example, if you take a $6,000 loss, but your AGI is $200,000, you lower your taxable income only by $2,000. On the other hand, if your AGI is $50,000, you lower your AGI by $5,000.
The last barrier to claiming your loss is itemizing your deductions. If you're not willing to part with your standard deduction, the IRS doesn't let you write off your 401(k) plan losses. On the bright side, when you itemize, you also get to claim any other itemized deductions you're eligible for, including mortgage interest, state and local taxes, and charitable contributions. So, if the total of your itemized deductions exceeds the value of your standard deduction, itemizing will benefit you.
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