Will the IRS let me use my gambling losses to offset contest winnings?
By Lani Luciano Reporter associates: Jan Alexander and Cindy Hsiao

(MONEY Magazine) – Q. I recently won $5,000 in a contest. I know my winnings are taxable, but can I reduce the bite by deducting my lottery losses and bad casino bets? STEVE EHRESMAN Whitestone, N.Y.

A. Gambling losses can offset only gambling gains. For your prize to qualify as a gambling gain, you must have wagered something of value in the contest, such as an entry fee. If that's the case, you can deduct your gambling losses up to the amount of your gains, though the IRS may require old lottery tickets, casino receipts or other proof. If you didn't ante up anything to participate in the contest, the IRS will consider your prize ordinary income, which gambling losses cannot offset.

Q. I'd like to exercise some company stock options and hold on to the stock. Can I use money from my Roth IRA to buy the shares? ERNEST WOODARD Woodhaven, Mich.

A. The only way to exercise the options using Roth IRA funds is to withdraw the money. The IRA can't buy the shares directly because it doesn't own the options--you do. Nor can you assign the options to your IRA, because that would be a contribution and IRA contributions can be made only in cash. So if you were hoping to get the stock into your Roth at the option price to avoid tax on the appreciated value when you sell it, you're out of luck. If your options are nonqualified--and most are--the difference between the option price and the share price when you exercise your options is taxable as ordinary income, but any future appreciation is tax deferred until you sell.

You should tap your IRA only if there's no other way to come up with the cash. To avoid a penalty, don't withdraw more than you've contributed to your Roth. If you must draw from earnings, make sure the options are valuable enough to make paying a penalty and taxes worth it. Better still, if you can, hold off exercising those options until you've had the account for at least five years and are at least 59 1/2. Then you can withdraw both contributions and earnings tax- and penalty-free.

Q. I planned to borrow against my 401(k) plan for the down payment on a home, but I recently changed jobs. The benefit brochures I received said my new retirement plan would allow me to take out a loan, so I transferred my money into the new employer's plan. When I applied for a loan, though, I was told that the company no longer allowed employees to borrow from the plan. Worse, the new plan's regulations say I can't withdraw the money either. Now I'm really stuck. Is there anything I can do? JASON CARR Denver

A. Not much, unfortunately. Loan and withdrawal policies are totally up to employers. Regulators can make the company correct its literature but can't require a change in policy. Even if you'd left your 401(k) money in your former employer's plan, as an ex-employee you couldn't have taken out a loan. Your only choice would have been to withdraw your savings, which might trigger a tax liability and a penalty.

You can ask the two employers to let you reverse the transfer if you still want to withdraw the money, but both would have to agree, and the paperwork involved makes that unlikely. Your best bet is to suspend new contributions to your retirement plan while you sock away cash and look for a low-down-payment mortgage. Or you may be able to find a no-down-payment mortgage (see MONEY's July issue, page 131). Remember, though, that you'll be putting your house at risk if you can't meet the payments.

Reporter associates: Jan Alexander and Cindy Hsiao