Tax harvesting from 529 plan?

If you started contributing to a 529 plan some time in 2007, the chances are that the plan is in the RED (with capital losses) due to the recent stock market conditions.

A thought came to my mind — since unqualified distributions from the 529 plan are taxable, is it possible to tax harvest from the 529 plan?

I asked this question on the Bogleheads forum, and here’s a reply from LH2004 (who had previously demonstrated to have very good knowledge on tax matters):

Yes. See “Losses on QTP Investments” in Publication 970. You’ll be subject to the 2% of AGI floor, though, so you’ll need to have really extreme losses, or a big account, or low AGI, or other miscellaneous itemized deductions to reach that floor.

Alternatively, under the IRS’s new theory regarding wash sales, you could take the position that a sale of an individual portfolio in the 529 plan at a loss, followed by a purchase of a substantially identical fund in your taxable account, is a wash sale, increasing your basis in the newly-purchased fund, which you could then immediately sell at a loss; that would be an aggressive position to take.

Taylor Larimore kindly found the link to the relevant section in Publication 970 — http://www.irs.gov/publications/p970/ch08.htm :

Losses on QTP Investments

If you have a loss on your investment in a QTP account, you may be able to take the loss on your income tax return. You can take 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, subject to the 2%-of-adjusted-gross-income limit.

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.

At this point, it doesn’t look like something I would do.

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