taxes

Claiming a loss in a 529 plan

George SaenzQuestionDear Tax Talk,
I lost money when I closed my grandchild's 529 plan. Is this loss tax deductible?
-- James

AnswerA: Dear James,

Some states establish and maintain qualified tuition programs, also called QTPs or 529 savings plans. The savings plan is intended to be used for paying a student's qualified education expenses at a postsecondary institution.

The beneficiary or student is designated on the account, but the school does not have to be assigned at any time. The contributions are flexible, and the available funds at the time the student enters college may or may not be sufficient to cover all expenses. The savings account is usually invested in conservative assets. As many learned when the market crashed, their investments in these accounts weren't as sound as they were led to believe. Hence, the accounts are sometimes worth less than the contributions.

As an alternative, some states or university systems create prepaid tuition plans. If you prepay tuition, the student (designated beneficiary) will be entitled to a waiver or a payment of qualified education expenses within that particular school system. This is a prepayment of the tuition to go to a particular state's university system. They may also be converted for use at private and out-of-state colleges, but it's not going to be at a good rate. There is no investment performance from the standpoint of the account owner, and hence these accounts do not incur losses.

Every state now offers a state section 529 plan: 32 states plus the District of Columbia offer just college savings plans, one state offers just prepaid tuition plans and 17 states offer both. Several hundred private colleges also offer a prepaid tuition plan for member colleges known as the Independent 529 Plan.

For Internal Revenue Services purposes, you cannot deduct either payments or contributions to a QTP. A total of 25 states offer a full or partial income tax deduction for contributions to their state's 529 plans. Distributions from a plan are usually tax-free if used for their intended purpose. If the child doesn't attend college, the money returns to the person that established the account. The kid can't convert it into a car.

A poorly performing QTP account may result in a loss. You can take the loss only when all amounts from that account have been distributed and the total distributions are less than your original contributions. You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23, subject to the 2 percent of adjusted gross income limit.

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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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