How Are Capital Gains and Losses in a 401(k) or Rollover IRA Treated?

Qualified retirement accounts, such as individual retirement arrangements and 401(k)s, offer tax-sheltered savings, which means the Internal Revenue Service has to keep its paws off the capital gains in your accounts until you take distributions. Whether the money sits in a 401(k) or a rollover IRA, the tax-sheltered status of the account is the same.

Annual Capital Gains

The good news about money in a tax-sheltered account, like an IRA or 401(k), is that you don't have to share a portion of your annual capital gains, or any other income earned in the account, with Uncle Sam. For example, say you sell shares in your 401(k) plan for a profit of $10,000. If that money were in a taxable account, you'd have to pay taxes on it. However, since it's in the 401(k) plan, you don't pay any taxes as long as it remains in the account.

Annual Capital Losses

The downside to using a tax-sheltered account is that when you do pick a loser, you don't get a tax deduction for that year. For example, say that you sell stocks in your IRA and take a $10,000 loss. If those shares weren't in your traditional IRA plan, you would get to use that loss to offset your capital gains and potentially some of your ordinary income. However, when you take the loss in your IRA, you don't receive any tax benefits.

Overall Loss Deduction

If you've taken a horrible loss in your account, it's possible, but very difficult, to qualify for a tax break. The only way you're allowed to claim a deduction is if you close all of the same types of accounts, such as all 401(k)s or all IRAs of the same type, and the amount of your total distribution from those accounts falls short of your basis for the account.

For example, say you have a Roth IRA with a basis of $40,000, you close it and receive $20,000 and you've received $10,000 in distributions in the past. Since your distributions of $30,000 are less than your basis of $40,000, you have a $10,000 loss. However, your work isn't done yet. You can only deduct the portion of the loss that exceeds 2 percent of your adjusted gross income. So, if you have a $10,000 loss, but an AGI of $100,000, you only actually get to deduct $8,000.

Retirement Plan Basis

The basis for your retirement plan equals that amount of after-tax contributions that you've made to the account over the years. For traditional IRAs and 401(k)s, that means that unless you've made nondeductible contributions, you're never going to have a deduction. Though this might sound unfair, you've already deducted all of your contributions because they were never included in your taxable income. If you have a Roth 401(k) or Roth IRA, on the other hand, all your contributions add to your basis because you're not allowed to deduct your deposits.