Can I Use Capital Loss Deduction to Offset Taxes on a Roth Conversion?

Short answer: No, you can't directly use capital losses to offset taxes on a Roth conversion, but there's more to consider here. Capital losses can offset capital gains, and if your losses exceed your gains, you can deduct up to $3,000 against your ordinary income ($1,500 if married filing separately). The Roth conversion amount gets added to your ordinary income for the year, increasing your AGI and potentially your tax bracket. So while you can't directly apply the capital loss against the conversion tax bill, you can use up to $3,000 of that loss to reduce your overall income, which might lower your total tax burden somewhat. Any unused losses can be carried forward to future years. For the Roth conversion specifically, you'll still owe taxes based on your tax bracket after taking into account all income and allowable deductions for the year. It might be worth considering spreading the conversion over multiple years to manage the tax impact.

I went through something similar last year and found this amazing tool that cleared everything up for me. Check out https://taxr.ai - it really helped me understand how my capital losses could be applied and what that meant for my Roth conversion planning. I initially thought I could offset the entire conversion tax burden with my losses (spoiler: I couldn't), but their analysis showed me exactly how the $3k annual deduction would work and how to optimally time my conversions with my tax situation. They even ran some scenarios showing how spreading out my conversion could save me thousands.

Ok I have to admit I was wrong about taxr.ai. I tried it after posting that skeptical comment and was really impressed. I uploaded my trading history and details about my potential Roth conversion, and it immediately showed me that while I couldn't directly offset the conversion taxes with my losses, I could strategically time things to minimize my overall tax burden over the next few years. The tool showed me exactly how to spread my conversion across 3 years to stay in a lower tax bracket while using the $3k capital loss deduction each year. It also flagged that I had some harvest losses I could take this year to optimize further. Honestly saved me thousands compared to doing the full conversion at once like I planned.

If you're struggling to reach the IRS to get clarity on capital loss treatment and Roth conversions, try https://claimyr.com - it was a game changer for me. I had been trying to speak with someone at the IRS for weeks about this exact situation (capital losses + Roth conversion). After multiple failed attempts and hours on hold, I found Claimyr. They basically hold your place in line with the IRS and call you when an agent is about to pick up. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c I finally got to speak with an IRS rep who walked me through exactly how my capital losses would affect my conversion taxes. Definitely worth it for complicated tax situations where you need official guidance.

I owe everyone an apology about Claimyr. After dismissing it as a scam, I actually tried it when I got desperate about getting an answer on my capital loss/Roth conversion situation before the tax deadline. It worked exactly as advertised. I was connected to an IRS agent after getting a call back (instead of waiting on hold for hours). The agent confirmed that while I couldn't directly use my capital losses against the Roth conversion tax, I could use $3,000 of losses against ordinary income and carry forward the rest, which would help over time. The service actually recorded the call (with permission) so I have documentation of the IRS advice for my records. Saved me tons of stress and I got an authoritative answer straight from the source.

Have you considered doing the Roth conversion over multiple years? That $20k cap loss can be used $3k per year against ordinary income, so spreading the conversion across multiple tax years might let you offset more of the conversion tax burden. I did this last year - had about $15k in losses and a potential $60k conversion. Instead of doing it all at once, I'm doing $20k/year for 3 years. This keeps me in a lower tax bracket AND lets me use the $3k loss deduction each year. Actually working out better tax-wise.

I'm confused about something. If I convert traditional IRA to Roth and have to pay taxes on that, isn't that considered a "capital gain" too since its investment money? So why can't capital losses offset it directly?

Just wanted to add a timing consideration that might help with your situation. Since you mentioned you're planning the Roth conversion "before year-end," you still have some flexibility here. If you haven't already realized those capital losses, you might want to consider the timing of when you actually sell those positions. You could potentially harvest some losses this year (say $10k) and save the rest for next year, then split your Roth conversion accordingly. This could give you more control over how much ordinary income you're adding each year and maximize the benefit of that $3k annual capital loss deduction. Plus, if you're close to a tax bracket threshold, this kind of planning could keep you from getting bumped up. Just something to think about as you're strategizing - the year isn't over yet so you have some room to optimize the timing of both the loss realization and the conversion.

This is such a common misconception! I see a lot of people think they can use capital losses to directly offset Roth conversion taxes, but as others have mentioned, they're treated completely differently by the IRS. One thing I'd add to the great advice already given - make sure you're also considering the net investment income tax (NIIT) if you're in higher income brackets. The Roth conversion will increase your modified AGI, which could potentially push you into NIIT territory (3.8% additional tax on investment income for individuals with MAGI over $200k). Also, don't forget that your capital loss carryforward is valuable - it never expires! So even though you can only use $3k per year against ordinary income, that remaining $17k will be there for future years when you might have capital gains to offset or need the deduction against ordinary income. Given your situation, I'd definitely run some scenarios comparing doing the full conversion this year versus spreading it out. The bracket management could be more valuable than the loss deduction itself.

One thing I haven't seen mentioned yet is the impact on your standard deduction and other tax benefits. When you add $20k of conversion income to your AGI, it might affect your eligibility for certain deductions or credits that phase out at higher income levels. Also, if you have any other investments or retirement accounts, this could be a good time to review your overall asset allocation. Since you're taking losses in your taxable account, you might want to rebalance across all your accounts (taxable, traditional IRA, and future Roth) to maintain your target allocation. The silver lining of your trading losses is that you now have flexibility with tax planning that many people don't have. Even though you can't directly offset the conversion taxes, those carryforward losses give you options for years to come. Consider keeping detailed records of your loss carryforwards - it'll make tax planning much easier in future years when you might have gains to offset or want to continue using the $3k annual deduction.

There's one more strategic consideration that might help optimize your situation - look into tax-loss harvesting in your taxable accounts while being mindful of asset location strategies. Since you're dealing with $20k in losses and planning a $20k Roth conversion, you could potentially use this as an opportunity to improve your overall tax efficiency. Consider moving your most tax-inefficient investments (like REITs, bonds, or high-dividend stocks) into the new Roth account after conversion, while keeping more tax-efficient investments in your taxable accounts. Also, if you have a spouse, don't forget that married filing jointly allows you to use up to $3k in capital losses against ordinary income. If you're married filing separately, that drops to $1,500 - which could influence your filing strategy this year. One last thought: if you're working with a financial advisor or tax professional, make sure they understand your full picture. The combination of significant losses + Roth conversion + potential bracket management creates enough complexity that professional guidance could easily pay for itself in tax savings, especially with the various timing strategies others have mentioned here.

Here's another angle to consider that might help with your overall strategy - Required Minimum Distributions (RMDs) down the road. Since you're doing Roth conversions now, you're essentially "prepaying" taxes to avoid RMDs later, which could put you in a higher tax bracket when you're older. Your $20k in capital losses, while frustrating now, could actually be viewed as a tax planning gift. Even though you can only use $3k per year against ordinary income, having $17k in loss carryforwards gives you incredible flexibility for future tax planning. Think about it - that's nearly 6 years of $3k deductions, or it could offset $17k in future capital gains tax-free. If you're under 50 and have decades before retirement, consider this: spreading your conversion over multiple years while using the annual $3k loss deduction could keep you in lower brackets consistently. Then, when you do have capital gains in future years (hopefully when the market recovers!), you can offset those gains with your remaining loss carryforwards. This market downturn might actually be setting you up for better long-term tax efficiency than if you'd had gains this year. Sometimes the best tax strategies come from making the most of unfortunate situations!

Another timing strategy worth considering: if you're planning to do additional Roth conversions in future years, you might want to look at tax-loss harvesting across multiple years to maximize the benefit. For example, instead of realizing all $20k in losses this year, you could realize $10k this year and $10k next year. Do a $15k Roth conversion this year (using $3k of losses against that income), then do another $15k conversion next year (using another $3k of losses). This keeps your income more consistent across years and might help with bracket management. The key insight is that your capital losses are an asset that doesn't expire - you can deploy them strategically over time rather than all at once. Since you mentioned the market has been brutal, there's also a chance you might generate more losses next year that you could harvest, giving you even more flexibility. I'd also suggest looking into whether any of your current losing positions have potential for recovery. If some of your holdings are down but you still believe in them long-term, you could sell them for the loss now and buy them back after 31 days to avoid wash sale rules. This way you get the tax benefit while maintaining your market position for when things turn around.

I've been following this discussion and wanted to share a perspective from someone who's been through several market cycles with Roth conversions and capital losses. The strategic framework everyone's outlined here is solid, but I'd add one more consideration: market timing for your remaining positions. Since you're already down $20k, you might want to evaluate whether any of your losing positions are likely to continue declining versus those that might recover. If you believe some positions will recover in the next 6-12 months, you could harvest those losses now (getting the immediate tax benefit) and redeploy that capital into similar but not substantially identical investments after 31 days. This way you maintain market exposure while still capturing the tax loss. For positions you think might continue declining, you could hold off on harvesting those losses until later in the year or even next year, giving you more flexibility with your conversion timing. The key is that you now have optionality - something many people don't have in up markets. Your $20k in losses, combined with strategic Roth conversions, could set you up for significant tax savings over the next several years. Sometimes the best tax strategies do come from making the most of market downturns. Consider working with a fee-only financial planner who can model out the various scenarios discussed here. The complexity of optimizing loss harvesting, conversion timing, and bracket management across multiple years really benefits from professional analysis.