When you make a contribution to an individual retirement account (IRA), you cannot make a direct transfer of stock, bonds, or real estate into the IRA. If you plan to put $5,500 into a traditional IRA in 2017, you must actually deposit those funds into the account with cash. If you an account holding $5,500 worth of Brown Forman (BF.A) sitting in a taxable account at the same brokerage house that holds your IRA, you are not permitted to make a direct in-kind transfer of the Brown Forman shares from your taxable brokerage account to your traditional IRA.
Instead, you must convert the Brown Forman shares into cash and pay a capital gains tax on those shares and then use the remaining to fund the traditional IRA.
This raises the question: If you must sell something to make an IRA contribution for the current year, is there any strategy or art to the process?
You should look to your taxable holdings that are currently sitting on a loss. Let’s say you had recently purchased Chevron stock at $110 per share and saw it fall to $70 immediately thereafter. Assume that you have at least $5,500 in Chevron stock that could be used to fund the traditional IRA. Here, you can sell the Chevron stock and receive the tax benefit of the capital loss, and then put that money into your IRA. This enables you to move your $5,500 into an account that has more tax benefits while simultaneously reaping a present tax benefit.
There is one catch. In 2008, The Internal Revenue Service issued Revenue Ruling 2008-5 that held wash rules apply to separate legal entities that are owned by the same individual.
This means that, in order to receive your capital loss from the sale of Chevron stock, you must do one of two things: (1) wait more than 30 days before purchasing Chevron stock in the IRA, or (2) allocate the $5,500 towards any asset in the world other than Chevron stock or options on Chevron stock. The IRS test is that you cannot invest in “substantially the same security” and it has not yet addressed the issue as to whether you can, say, purchase shares of a mutual fund that owns a heavy concentration of Chevron stock.
Obviously, the cleanest way to fund an IRA account is through your surplus income from your labor. However, circumstances arise in which you might want to try and stuff as much as you can into tax-deferred holdings that exceed the amount of liquid cash you have available. If you must sell something to shovel assets into tax-deferred accounts, you should focus on your worst-performing assets that permit you to secure a capital loss. Once you put the proceeds from the sale of the stock into an IRA, you must then refrain from buying the same stock in an IRA for thirty days or you can immediately put the capital to work inside the traditional IRA so long as you choose an investment that is not “substantially identical” to the one that you just sold.