If you ve been trying to save for a son or daughter's college years by investing in a 529 savings plan, you may have suffered major losses this year. If you decide to bail out, the losses may be tax deductible. But be careful: The IRS rules on this are a little hazy.

In Publication 970 (Tax Benefits for Education), the IRS says you can trigger a potential tax-deductible loss when you shut down a loser 529 account. Unfortunately, there s no other official or unofficial guidance. Here s my take:

The loss is potentially deductible when both of the following conditions are met:

*You liquidate all of the holdings in the 529 account(s) that you own under a particular state's plan for a particular beneficiary (college-bound child). Since you own the account(s), the liquidation proceeds go to you rather than the beneficiary.

* The total proceeds from liquidating the account(s) is less than your total basis in the account(s). Your basis in an account equals the amount of money you've contributed to it -- assuming you've made no withdrawals. So if you only have one account and have never taken anything out of it, you have a potentially deductible loss if the amount you receive from closing the account is less than what you put in.

It gets even trickier from here. There are additional hurdles to clear before you can collect any actual tax savings.

Miscellaneous Itemized Deduction Treatment

According to the IRS, your 529 account loss is a miscellaneous itemized deduction. As such, it gets thrown into the pot with other miscellaneous deductions (such as investment expenses). Only total miscellaneous deduction amounts that exceed 2% of your adjusted gross income (AGI) can be written off.

If you clear the 2%-of-AGI hurdle, you re still not home free. You may lose part of your write-off due to a phase-out rule for high-income individuals. And your deduction is completely disallowed under the alternative minimum tax (AMT) rules. So if you re an AMT victim, some or all of the hoped-for tax savings will go up in smoke.

Example:
Say you've put $50,000 into your one and only 529 account. Even though you've never taken money out of it, the account is now worth just $30,000. You re thinking about liquidating the darn thing and hoping for a tax deduction to ease your pain.

Liquidation Results: Since you haven't taken any withdrawals, your basis in the account is $50,000. Closing it would mean a $20,000 loss ($50,000 basis - $30,000 proceeds).

Deductible Loss Calculation: As mentioned, the IRS says your loss is a miscellaneous deduction subject to the 2%-of-AGI threshold. If your AGI is $150,000, the threshold is $3,000 ($150,000 x 0.02). Say you also have $1,000 of other miscellaneous deductions, for a total of $21,000 (529 plan loss of $20,000 + $1,000). You can deduct $18,000 ($21,000 - $3,000). However, if you're an AMT victim, that write-off is disallowed, and your actual tax savings may be whittled down or even eliminated.

Bottom Line: For our purposes, let s assume you re not an AMT victim. In your situation, closing the 529 account triggers an $18,000 write-off. If you re in the 28% federal tax bracket, you save $5,040 (0.28 x $18,000). Plus you get back what s left of your money.

Other Tax Considerations

You May Have to Repay State Income Tax Benefits
If you collected a state income tax write-off or credit when you invested in your state s 529 plan, then closing the account could mean you ll have to report a previously-claimed deduction in income on your state tax return or repay a previously-claimed credit.

You May Be Giving Up a Tax-Free Recovery
Say your loser 529 account recovers and becomes worth what you ve contributed and more. Assuming that you eventually end up draining the account to pay for qualified college costs, you won t owe any federal income tax on the difference between what the account is worth now and the higher value after it recovers.

Don t Reinvest Too Quickly
If you liquidate a loser 529 account to reap some tax savings, don t reinvest in another 529 within 61 days after liquidating the first one. If you do, the IRS may deem it as simply rolling over proceeds from one 529 to another -- and some or all of your loss deduction might go out the window.

Beware of Gift Tax Implications If You Reinvest
Say you made a lump-sum 529 plan contribution a couple years ago and spread it out over five years for gift tax purposes. If you liquidate the account, you may have to wait until the five-year period is over before making another significant contribution to a new account that is set up for the same beneficiary. Otherwise, you could face adverse gift-tax consequences. (The rules are unclear here.)

The Last Word

While closing a loser 529 account may cut this year s tax bill, the benefit may be less than you hoped. Plus, there are all of the other issues to overcome. All things considered, the clearest argument for liquidating is when you simply want (or need) your money back and the tax savings (if any) is just a bonus.