Thanks to their beneficial tax treatment, qualified tuition programs (QTPs—commonly referred to as 529 plans) have become the plan of choice for many taxpayers trying to save enough money to cover the ever-escalating costs of getting their child or grandchild through college. Over the last several years, many folks have invested a considerable amount of money in these plans. Unfortunately, the market has not been any kinder to these plans than to the rest of us. There are more than a few taxpayers out there who have QTPs worth less than what they put into them. That begs the question: Are the losses deductible? Better yet, can I liquidate the account, claim a loss, and then reinvest the proceeds in another QTP for my child or grandchild?
Yes—according to the IRS, a loss on a QTP is deductible by the account owner (the person who controls the account—typically the contributor), but only when all amounts from that account have been distributed and the total distributions are less than the contributor’s unrecovered basis (contributions made to the account less any prior withdrawals of those contributions). Unfortunately, the loss must be deducted as a miscellaneous itemized deduction subject to the two percent-of-adjusted-gross-income limit. The funds can’t be reinvested too soon. The IRS indicates that distributions rolled over to another QTP for that or another related beneficiary within 60 days of the distribution are not taxable. Thus, if an account that is worth less than what was put in it is rolled over within 60 days, there are no tax consequences, meaning no loss deduction.
The bottom line is this, if you liquidate a QTP account, wait more than 60 days to reinvest the proceeds, and get back less than you put in it; the loss is deductible as a miscellaneous itemized deduction subject to the two percent-of-adjusted-gross-income floor. Not so great—at least for most taxpayers! Therefore, we suggest you use this strategy carefully.
Michael Green of Michael L. Green Tax and Financial is an Enrolled Agent, and a Certified Financial Planner in the Valencia Industrial Center. He can be reached by calling 661-257-4111.