Deducting Qualified Tuition Plan 529 and Coverdell ESA Losses

When the value of a Qualified Tuition Plan (QTP) or Coverdell ESA (CESA) account is less than the unrecovered amount of contributions, the account owner can claim a loss, but only when all amounts from that account have been distributed and the total distributions are less than the unrecovered basis (IRS Pub. 970). Presumably, the loss is computed in accordance with the earnings computation rules, which means that accounts with the same state plan generally must be aggregated. The loss is allowed as a miscellaneous itemized deduction subject to the 2%-of-AGI limit and is disallowed for AMT purposes.

 

How to deduct loss on a 529 plan

If you have a loss on your investment in a QTP account, you may be able to claim the loss on your income tax return. You can claim the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions to that QTP account. You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit.

 

Other issues to consider when deducting a 529 or Coverdell Loss

There may be other issues to consider when terminating an account that has declined in value. For example, it would appear that an account owner who invests in another QTP or CESA within 60 days of terminating the first would be deemed to have made a rollover of the original account, thus preventing him from claiming a loss with respect to the first (since basis carries over to the new account).

 

Account owners of QTPs

Account owners of QTPs may intentionally trigger a loss by closing an account and withdrawing all of the funds in a nonqualified distribution. This may be beneficial since the generous contribution rules for QTPs mean that the plan can quickly be rebuilt. However, the QTP account owner is again potentially subject to the gift tax provisions when reestablishing the accounts.

 

Distributions from more than one QTP

If you have distributions from more than one QTP account during a year, you must combine the information (amount of distribution, basis, etc.) from all such accounts in order to determine your taxable earnings for the year. By doing this, the loss from one QTP account reduces the distributed earnings (if any) from any other QTP accounts.

 

State Tax Consequences of Taking Loss in 529

Withdrawals from a state’s QTP may trigger state tax consequences. Some states require withdrawals not used for qualified education expenses to be included in state taxable income, especially if a state deduction for making the contribution was allowed in a prior year. In addition, some states impose a penalty on nonqualified withdrawals.