It Pays to Keep Track of Your Roth IRA Contributions

I enjoyed your March 7 report, How Do I Report My Roth IRA Contribution? In the report, you said, "You should be required to report your contributions because it will help you keep track of your cost basis on the account."

Why is it important to keep track of the cost basis for a Roth IRA? I opened a Roth in 1998 and contributed $2,000 in each of the last two years. Since I've already paid tax on those contributions and interest accrues tax-free, why is knowing the cost basis important?

-- Joe McDonald

Joe,

Your Roth IRA's earnings do grow tax-free. And if you leave the account open for five years and wait until you're at least 59 1/2, your withdrawals will be tax- and penalty-free.

But what if you need the money before that?

You can withdraw money from your Roth IRA for higher education purposes, as a first-time homebuyer or upon the disability or death of the account owner at any time without incurring the 10% early withdrawal penalty. But you will have to pay tax on any earnings the account generated.

To figure out your tax hit, you'll need to know how much you've contributed over the years. Your cost basis in the account is the total of those contributions. This is where good record keeping becomes important.

Let's say you decide to withdraw $5,000 for graduate school. If you've contributed $4,000 over the last two years, you'll only owe tax on the $1,000 worth of earnings since you can pull your contributions out first.

If you withdraw the money before age 59 1/2 for any reason other than those listed above, you'll also owe penalties in addition to the taxes.

So you do need to keep track of your Roth IRA basis.

Margin Interest Deduction

Is it still possible to deduct margin interest expenses on Schedule D as a subtraction against capital gains?

-- Steve Eccles

Steve,

Margin interest is an investment expense, reported on Schedule A -- Itemized Deductions. It does not affect the cost basis of the underlying security, so you can't deduct it against your capital gains on Schedule D -- Capital Gains and Losses.

Since it's reported on line 13 of Schedule A, there's no adjusted gross income limitation on that interest as there is with the other investment-related deductions we discussed in Saturday's Tax Forum.

Margin interest generally is limited to the amount of investment income you have, though. Form 4952 -- Investment Interest Expense Deduction will help you determine just how much will qualify as a deduction in the current year. But if you have $1,000 in margin interest and only $600 in net investment income, you can only take a $600 margin interest deduction.

Any unused interest can be carried forward indefinitely.

If you do not itemize your deductions and instead take the standard deduction, you can't deduct margin interest that year. But you can carry a portion of that interest forward. So if you itemize in future years, you may be able to deduct the interest at that time. Form 4952 will help you determine just how much of that interest qualifies as a deduction in the current year and how much you can carry forward.

Note that you can't intentionally hoard margin interest for future years. If you qualify for the deduction this year you have to take it, or you will lose it.

Tip for traders: Report your margin interest as an investment expense on Schedule C.

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