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IRA Withdrawal (Penalty-Free) for Homebuyers

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By Roy Lewis

You can't often take an early distribution (i.e., prior to age 59 1/2) from your IRA (or Roth IRA) account and avoid the dreaded 10% penalty. But, surprisingly enough, this is one of the tax benefits that was enacted as part of the 1997 Taxpayer Relief Act to help people become homeowners.

The law allows individuals to receive distributions from their IRAs to pay up to $10,000 of first-time homebuyer expenses without incurring the 10% early withdrawal penalty that usually applies to withdrawals from an IRA before age 59 1/2. But, even though the penalty is waived, you will still be required to pay taxes (as applicable) on the IRA withdrawal itself.

In an odd twist of government logic (is there really such a thing?), you should know that a "first-time homebuyer" doesn't really have to be a first-time homebuyer, since the law defines "first-time homebuyer" as someone who has not owned a home for two years. So, in addition to benefiting "first-time" homebuyers, the law also helps "not-recent" homebuyers.

And, in yet another twist of government logic, you can take advantage of the provision even if you are not the homebuyer. Huh? Well, the law states that the first-time homebuyer can be the IRA owner, his or her spouse, or any of his children, grandchildren, or ancestors. So, maybe this provision should really be called, "Penalty-Free Withdrawal for Not-So-Recent Homebuyers and/or Relatives of an IRA Owner." You be the judge.

Anyway, the $10,000 is a lifetime limitation on the amount of withdrawals that can be pulled out of the IRA penalty-free under the first-time homebuyer provision. So, don't think that you'll get this relief each and every time you want to buy another home. Once you use up your $10,000, you're done. And, while the law isn't crystal clear, it seems permissible that, for example, a husband and wife helping one of their children scrape together a down payment could each withdraw up to $10,000 from their respective IRAs without incurring any penalty for early withdrawal.

But, you need to know that any IRA funds distributed to you must be used to pay qualified acquisition costs before the close of the 120th day after the day you received the distribution -- so this isn't a completely "open-ended" deal. You need to plan your purchase and your distribution carefully. You should also know that qualified acquisition costs include the costs of buying, building, or rebuilding a home and any usual or reasonable settlement, financing, or other closing costs. So, the distribution must be related to the purchase of the property and can't be used for other home-related expenses such as furnishings or general home repairs or maintenance.

Remember that a loan repayment isn't a "qualified acquisition expense." For example, say you purchased a home 3 months ago and just found this exception for a penalty-free IRA distribution. Could you take the $10,000 now and use it to pay off a portion of your mortgage? Well... you certainly could, but because this loan repayment is not deemed a "qualified acquisition expense" your $10,000 distribution would certainly be subject to the early distribution penalty. So, if you're interested in the penalty savings, you'll have to make sure that you plan ahead... and not behind.

And finally, this benefit is only available for IRA accounts -- not for 401(k) or 403(b) accounts or any other type of retirement account. This can be a complicated issue. If you have any additional question on this or any other tax issues, please leave them in the Tax Strategies discussion board.

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