529 Plan Liquidations

As a result of today's market environment, the value of many 529 plans have declined below the taxpayer's original cost basis resulting in unrealized losses. In some cases, taxpayers will simply roll over the 529 plan into another account. However, for these taxpayers, a potential tax planning alternative is to liquidate the plan to generate a tax loss. The IRS has stated that a loss from the liquidation will result in a miscellaneous itemized deduction, presumably to the taxpayer who funded the 529 plan. As a miscellaneous itemized deduction, the deduction is added to other miscellaneous itemized deductions and the total of such deductions is deductible to the extent it exceeds 2% of adjusted gross income. Although deductible for regular tax purposes, such miscellaneous itemized deductions are not deductible for alternative minimum tax purposes. For those taxpayers who would benefit from this, a few cautionary notes are in order. First, following rules for claiming losses on IRAs with basis, it would appear that all of the owner's 529 accounts must be liquidated in order to generate the loss. Second, it would be prudent to not make contributions for 61 days after liquidation to another 529 plan for the same beneficiary or a member of the beneficiary's family to avoid unintended rollover treatment.

For many taxpayers who may receive little if no tax benefit from a liquidation, it may be better to preserve tax basis in the 529 plan and reduce potentially future taxes and penalties resulting from possible nonqualified distributions by simply rolling over the plan into another plan. A rollover may be more efficient for gift tax purposes too. A liquidation followed by a contribution to another 529 plan will result in a second gift for essentially the same funds. A rollover avoids gift taxes except where the beneficiary is changed to a lower generation.

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