Question: I made a large (nearly 6 figure) investment in my self directed IRA account in an oil & gas investment (direct ownership WI in 3 oil wells). The entire investment is gone as the principals behind it scammed everybody & offshored most of the funds. Can you claim a loss on a IRA account investment gone bad?
Answer: I am sorry you experienced a loss in your IRA but thank you for your inquiry. To answer your question, you may be able to claim some of your loss on your personal tax return in this case, but there are significant limitations. The rules are discussed on page 41 of IRS Publication 590 for 2010 in the paragraph entitled “Recognizing Losses on Traditional IRA Investments” which you can download from www.irs.gov. To summarize briefly the rule, you may deduct the difference between the total amount of your remaining after-tax contributions in the account (your basis) and the amount withdrawn from your traditional IRAs as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor on your Schedule A. In other words, if the amount of non-deductible contributions in all of your IRAs was $10,000 and you closed all of your traditional IRAs down with zero money coming back to you, you would be able to claim the $10,000 on your Schedule A to the extent it exceeds 2% of your adjusted gross income for the year. Any such deduction is not counted when calculating the Alternative Minimum Tax, so if you are subject to that tax it may not do you much good. Note that it is only your unrecovered basis (after-tax contributions) in your IRAs that you can base the loss on, not the actual amount you lost in the deal. If you had no unrecovered basis in your traditional IRAs, you cannot take the loss. The rationale for this seemingly harsh rule is simple – if you never paid taxes on the money you lost you cannot deduct the loss from your taxable income. Also, as noted above, the only way you can take such a loss is when all of the amounts in all of your traditional IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis in the account.
As you can see from the answer to your question, the rules are a bit complex, so you will absolutely want to work with your CPA or other tax advisor to see the tax effect in your individual situation. Although I can give you the general rule, I cannot give you tax advice.
In an unrelated issue, I wanted to make you aware that if you purchase a working interest in an oil and gas well (as opposed to a royalty interest) in your IRA in the future, any income may be subject to unrelated business income tax (UBIT), and your IRA would need to file IRS Form 990T. While this does not mean that you should not make the investment necessarily, you should understand the tax implications for your IRA prior to entering into this type of investment. A careful analysis may reveal that such investments are better made outside of the IRA, since there may be significant tax deductions available to you. You may find more information on UBIT from IRS Publication 598.
If I can assist you in any other way, please let me know. Have a great day!