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

Uncle Sam might ignore gains on a rollover.
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Many employers offer qualified retirement plans, such as 401(k)s, to their employees. You can roll your 401(k) money into an individual retirement account when you leave the job or reach age 59 1/2. You can transfer your cash and other assets to the IRA, but you can also withdraw assets, sell them, and deposit the cash into the IRA. You might be able to avoid taxes on the capital gains from the sale.

401(k) Distributions

Unless the distribution is ineligible for rollover, you can roll any portion of your cash and property distributions from your 401(k) into an IRA. The Internal Revenue Service prohibits the rollover of certain distributions, such as those made because of financial hardship or for correcting excess contributions. While you can transfer the property to the IRA, you can’t keep the property and substitute cash or other property in its place. You are allowed to roll over the proceeds from the sale of the property. You treat any increase in value as part of the distribution and do not include the capital gain in your current income. On the minus side, you can’t deduct any losses from the rolled-over proceeds. In other words, you ignore capital gains and losses on rollovers.


Suppose you leave your job and receive a distribution from your 401(k) made up of $100,000 in cash and $100,000 in various stocks, not including any stock from your employer. Two weeks after receiving the distribution, you sell the stocks and score a $20,000 profit. You can roll the $100,000 in distributed cash and the $120,000 in sale proceeds into your IRA without including the $20,000 gain in your current income. Special tax deferments might apply for 401(k) distributions of your employer’s stock if you choose not to roll it over. You can’t roll over any dividends received on your employer’s stock.

Rollover Rules

If you take a distribution from your 401(k), the custodian will withhold 20 percent of the value for income tax. You have 60 days to complete a rollover once you receive the distribution. If you miss the deadline, you’ll have to include the distribution in your current income and might have to pay a 10-percent penalty if you’re younger than 59 1/2. You can avoid withholding and deadlines by arranging a trustee-to-trustee transfer from your 401(k) to your IRA.

Cost Basis

You normally include in your current ordinary income any withdrawals from your IRA, including withdrawals of money rolled over from a 401(k), but you don’t fork over taxes on withdrawals of your IRA’s cost basis. The cost basis equals the amount of nondeductible contributions made. If you contributed after-tax money to your 401(k), you can include that portion in a rollover to an IRA and add it to your IRA’s cost basis. You must prorate your cost basis for IRA withdrawals. This means you can’t simply withdraw just the cost basis and avoid tax on the entire distribution.

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