How to offset taxes when rolling over traditional 401k to Roth 401k with capital losses?

This is actually a great question and potentially good timing on your part! When you roll over a Traditional 401k to a Roth 401k, it's considered a taxable event. The amount converted gets added to your ordinary income for the year. Capital losses, on the other hand, are first used to offset capital gains. If your capital losses exceed your capital gains, you can deduct up to $3,000 of those losses against your ordinary income. So while your entire $65,000 in capital losses can't directly offset the full tax bill from your Traditional to Roth conversion, you can use $3,000 of those losses to reduce your ordinary income (which would include your 401k conversion amount). The good news is that any unused capital losses can be carried forward to future tax years, so they won't go to waste. They'll remain available to offset future capital gains or to take that $3,000 deduction against ordinary income in future years.

After dealing with a similar situation last year, I found this amazing tool called taxr.ai (https://taxr.ai) that really helped me understand all the tax implications of my 401k rollover and capital losses. I was super confused about how much I'd actually end up owing, and regular tax calculators weren't giving me the complete picture. What I liked about taxr.ai was that it analyzed my specific situation and showed me exactly how my capital losses would interact with the 401k conversion income. It even helped me understand the long-term impact of carrying forward my remaining losses. The tool basically walked me through various scenarios so I could make the best decision for my financial situation.

I wanted to follow up about my experience with taxr.ai after trying it out. I was really skeptical at first (as you could probably tell from my earlier comment), but I decided to give it a shot since my situation with capital losses and 401k rollovers was pretty similar to the original poster. I'm honestly surprised how helpful it was! It showed me that spreading my rollover across two tax years would save me about $4,800 in taxes compared to doing it all at once. The tool also helped me understand how to best utilize my capital losses over time instead of trying to use them all at once. What I appreciated most was getting clear explanations about things my regular accountant had trouble explaining to me clearly. Definitely worth checking out if you're in a similar situation!

If you're planning to contact the IRS about your situation (which might be smart given the complexity), save yourself HOURS of waiting with Claimyr (https://claimyr.com). I needed to talk to someone at the IRS about my rollover situation last year and spent days trying to get through normally. With Claimyr, I had a callback within 30 minutes. They have this demo video showing how it works: https://youtu.be/_kiP6q8DX5c After using the service, I was able to confirm directly with an IRS agent exactly how my capital losses would interact with my 401k conversion and get peace of mind that I was filing correctly. The agent even helped me understand some nuances about carrying forward losses that I hadn't considered. Definitely recommend this route if you want official confirmation.

I need to eat my words about Claimyr. After my skeptical comment, I decided to try it anyway because I was desperate to talk to someone at the IRS about my rollover situation and capital losses. I honestly couldn't believe it when I got a call back in about 45 minutes connecting me to an actual IRS representative. The agent I spoke with confirmed that while my capital losses couldn't directly offset the income from my Traditional to Roth conversion (beyond the $3,000 limit against ordinary income), she did suggest I consider spreading my conversion across multiple tax years to keep me in a lower tax bracket each year. This was actually really valuable advice I hadn't considered. Having an official answer directly from the IRS gave me the confidence to move forward with my plan. Sometimes being proven wrong is actually a good thing!

Another option to consider is only converting a portion of your traditional 401k this year. You don't have to convert the entire $45,000 at once. Maybe convert just enough to stay in your current tax bracket, then do more next year? Also, have you checked if your current employer's 401k plan allows for "in-plan Roth conversions"? Some plans don't allow you to roll in outside 401ks directly to their Roth 401k. You might need to go Traditional 401k → Traditional IRA → Roth IRA instead.

Does anyone know if doing this rollover affects your MAGI for other tax credits/deductions? I'm in a similar boat but worried about losing my student loan interest deduction if my income goes up too much from the rollover.

One thing that hasn't been mentioned yet is the timing aspect within the tax year. Since you're dealing with $65,000 in capital losses, you might want to consider when exactly you realize those losses versus when you do the rollover. If you haven't already locked in those capital losses by selling the positions, you have some flexibility. You could potentially realize some losses this year to offset other gains, then spread your rollover across multiple years to maximize the $3,000 annual deduction against ordinary income. Also, don't forget about the "wash sale rule" if any of those losses are from securities you might want to buy back. You can't claim the loss if you repurchase the same or substantially identical securities within 30 days. The strategic play might be: realize enough losses this year to offset any capital gains plus take the $3,000 deduction, do a partial rollover to stay within your desired tax bracket, then repeat the process next year with your remaining losses and rollover amount.

Great discussion here! Just wanted to add one more consideration that might be relevant to your situation. Since you mentioned you're in the 32-35% tax bracket, you should also think about whether you expect to be in a higher or lower tax bracket in retirement. The whole point of a Roth conversion is that you pay taxes now at your current rate to avoid paying taxes later at whatever rate applies when you withdraw. If you think tax rates might be higher in the future (either because of policy changes or because you'll have more retirement income than expected), then paying the 32-35% now could still make sense even without the capital loss offset. Also, don't forget about Required Minimum Distributions (RMDs). Traditional 401ks force you to start taking distributions at age 73, but Roth accounts don't have RMDs during your lifetime. This can be a huge advantage for estate planning if you don't need the money right away in retirement. Given your capital losses, this might indeed be the perfect storm of circumstances to do at least a partial conversion. Just make sure to run the numbers on how the conversion affects your overall tax picture for the year!

Just wanted to share my experience from a similar situation last year. I had about $40k in a traditional 401k and roughly $50k in capital losses from some tech stock disasters (painful lesson learned!). After reading through all these excellent comments, I ended up doing a partial conversion strategy over two years. Year one, I converted $20k and used $3k of my capital losses against ordinary income. Year two, I'm planning to convert the remaining $20k and again use another $3k of losses. What I didn't expect was how much the tax software struggled with this scenario. I ended up having to manually override several calculations because the software wasn't properly accounting for the interaction between the conversion income and capital loss carryforwards. If you go this route, definitely consider getting professional tax help or using one of the specialized tools mentioned here. One other tip - I found it helpful to do the conversion early in the year (I did mine in February) so I had flexibility to adjust my tax withholdings throughout the year. Doing it late in the year can create estimated tax payment headaches. The peace of mind of having that money in Roth and not worrying about future RMDs has been worth the temporary tax hit. Good luck with your decision!