PONZI SCHEME
CAN A ROTH IRA WRITE OFF FOR TAX PURPOSES LOSSES SUSTAINED FROM A PONZI SCHEME? iF SO, WOULD THE LOSS BE REPORTED ON THE BENEFICIARY’S TAX RETURN?
FACTS:
1. ROTH IRA INVESTED IN NON-PUBLIC REAL ESTATE INVESTMENTS OPERATED BY 3RD PARTIES. THE 3RD PARTY OPERATOR STOLE MOST OF THE INVESTMENTS. COURT HAS DETERMINED THE THEFT WAS A PONZI SCHEME.
2. IF FUNDS WERE INVESTED BY A REGULAR IRA, CAN THE BENEFICIARY TAKE A DISTRIBUTION FROM THE IRA AT THE DEPRESSED VALUE OF THE INVESTMENT, REPORT THE FMV AS TAXABLE INCOME AND THEN CONVERT THE DEPRESSED ASSET TO A ROTH IRA?
Permalink Submitted by Alan - IRA critic on Tue, 2021-06-29 19:01
Effective in 2018 (TCJA), there is no longer a misc itemized deduction allowed for cashing in IRAs for less than their remaining basis. The TCJA is scheduled to sunset in 2025. Since Roth IRAs tended to have high basis since all contributions are post tax, this deduction used to mainly be applied to Roth IRA losses. TIRAs are mostly funded with pre tax dollars, so TIRA basis is typically 0 or a very small portion of total value.
When fraud is involved with an IRA investment such as a ponzi scheme, there is typically a class action lawsuit filed against the perpetrator. Of course, legal fees offset much of the proceeds, but after settlement a check may be issued payable to the IRA. This is referred to as a “restorative payment” and such a check can be endorsed over for deposit back to the IRA (or a new IRA if the original account no longer exists) according to the IRS. It is usually handled as a non reportable transfer and should not generate a 1099R or 5498 from the custodian. But there is no deduction allowed for any loss of value.
Re Q 2: A depressed asset in a TIRA can be converted like any other investment. The 1099R should report the actual reduced value of the asset on the day of the conversion as 1099R taxable income. If the asset then recovers all or part of it’s former value in the Roth IRA, the gains in the Roth will eventually be tax free.