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This may be a naive question, but to me this seems like it should work.

Say I earn $1,000 this year in capital gains from selling some stock that appreciated. I think this is taxed at the capital gains tax rate, i.e. 15%. So my tax hit is $150. It seems that I could then add my after-tax $850 to an IRA and deduct this from my income for this year against my income tax rate, which is 25%, meaning a tax savings of $212.50.

By doing this, it seems like I can contribute the $850 to my IRA as normal, and also keep an extra $62.50 in non-retirement cash from tax savings. I think that IRA contributions must be from my "income", but once capital gains are deposited to my account, it just becomes "money" along with the rest of my income in that account. Is this legit? Am I missing something?

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As littleadv suggested, you are mixing issues. If you have earned income and are able to deduct an IRA deposit, where those actual dollars came from is irrelevant.

The fact that you are taking proceeds from one transaction to deposit to the IRA is a booking entry on your side, but the IRS doesn't care.

By the way, when you get that $1000 gain, the broker doesn't withhold tax, so if you take the entire $1000 and put it in the IRA, you owe $150 on one line, but save $250 elsewhere, and are still $100 to the positive on your tax return.

1

IRA contribution must be from your earned income in the sense that you cannot contribute to IRA more than you have in earned income. If all your income is capital gains - you cannot contribute anything to IRA.

Once you're within the income limit restriction, it doesn't matter what other money you have, because as you said - once in your account, its all just money. But what you're describing is basically "I deposit $850 from my salary into an IRA and then go pay for my gas with the $850 I have from the capital gains", so you're not paying any less taxes here.

If it makes you feel any better, you can describe it to yourself the way you did. It doesn't really matter.

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