Cost basis usually comes into play when you're selling assets to determine your gain or loss. However, it also has an application to your IRAs in certain circumstances. If you do have a cost basis for your IRA, keep track of it because it might matter when you're taking distributions.
Cost basis can matter for tax purposes when you start taking distributions from your IRA. It can also be relevant when you're trying to claim losses.
Calculating Cost Basis
Your cost basis for your IRA equals the amount of nondeductible contributions you've made to the account minus any tax-free withdrawals you've taken. When figuring your cost basis, you group all of your IRAs of the same type together, such as all Roth IRAs or all traditional IRAs. For example, if you have two traditional IRAs, your cost basis is calculated using your contributions to both accounts. But, if you have a Roth IRA and a traditional IRA, you calculate your cost basis for each account separately.
Traditional IRAs With Basis
Having a basis in a traditional IRA is uncommon because most people fund traditional IRAs with pretax dollars: that's the main tax advantage of contributing to a traditional IRA. If you have chosen to make nondeductible contributions, however, your cost basis comes into play when you take any distribution: The withdrawals are prorated between your cost basis and the remainder of the account, and the cost basis portion comes out tax-free.
For example, say that your traditional IRA has a cost basis of $30,000 and is worth $100,000 when you take a $10,000 withdrawal. That means 30 percent of the withdrawal comes out of your cost basis and is tax-free; 70 percent comes from the remainder of the account and is taxable.
Roth IRAs With Basis
Cost basis for Roth IRAs only matters when you're taking an early withdrawal. If you do cash out money early, it all comes out of your cost basis first, rather than being prorated like a traditional IRA distribution.
For example, say that your Roth IRA has a cost basis of $30,000 and is worth $100,000 when you take a $10,000 early withdrawal. The entire $10,000 comes out as a tax-free distribution, reducing your remaining cost basis to $20,000. Of course, once you can take qualified withdrawals, your entire distribution comes out tax-free anyway, regardless of your cost basis.
Claiming Losses on Your IRA
Your cost basis can also come into play if you're attempting to claim a loss on your IRA. You're only allowed to claim a loss if, after closing your accounts and taking all your total distributions from one type of IRA – all your traditional IRAs put together or all your Roth IRAs put together – the amount you receive is smaller than your nondeductible contributions.
For example, say you've made $30,000 of nondeductible contributions to your only Roth IRA and never taken any distributions. If you receive only $20,000 when you close your account, you have a $10,000 loss. But note, even this loss is limited, you can only claim the portion that exceeds 2 percent of your adjusted gross income for the year, and only if you itemize.
- How to Tax an Inherited IRA
- How to Calculate the Basis Across Multiple IRAs
- How to Calculate the Basis for Roth IRA Conversions
- Rules Governing Withdrawals From IRA Accounts
- Tax on Early Distributions of a Traditional IRA
- How to Calculate Adjusted Gross Income & Capital Gains
- Do SEP IRA Withdrawals Count as Income?
- How Much Will an IRA Reduce My Taxes?