Using Your IRA to Buy Your First Home
With home prices continuing to soar, many first-time homebuyers are looking for any possible source of funds to tap. IRA savings are intended to be used for your retirement. However, if you are like many others, your IRA may be your biggest asset. You may need your IRA money to make homeownership happen, and there is a special break in the tax code that can help if you qualify.
Penalty-Free Distributions
Usually, if you are under age 59½ and you take a distribution from your IRA, you will be hit with not only taxes but also a 10% early distribution penalty. However, there is a list of exceptions to this penalty. One of these can be used by those who are looking to take the leap and purchase their first home. The penalty does not apply to an IRA distribution that you use to buy or build a principal residence if you are a first-time homebuyer. You can also use IRA funds to pay for the settlement fees, closing costs, and financing fees. Remember, if you qualify, your distribution will still be taxable, even though the 10% penalty won’t apply. Also, the exception does not apply to plan withdrawals used to pay for home purchase expenses.
First-Time Home Buyer
Who is considered to be a first-time home buyer? The answer is surprising. You qualify as a first-time homebuyer if you haven’t owned a principal residence in the past two years. That’s right. Even if you had previously owned a home, but sold it three years ago and rented an apartment ever since, you would qualify. If you’re married, your spouse also cannot have owned a principal residence in the past two years. Certain family members can take a distribution from their IRA to help you with a home purchase as long as you meet the definition of a first-time buyer.
Limitations
Unfortunately, you do not have access to an unlimited amount of penalty-free IRA funds to purchase your first home. There’s a $10,000 lifetime limit on penalty-free distributions that you can use for a first-time home purchase. There is good news for married couples. If you and your spouse each have your own IRAs and qualify as first-time homebuyers, each of you can take $10,000 for a total of $20,000 for the same home purchase. If you take more than $10,000 from your IRA, the amount above won’t be exempt from the 10% penalty. Once you use up your lifetime limit, it is gone forever.
You must use the distribution within 120 days from the day it is received to buy your first home. If things don’t go as planned and the home purchase is delayed or cancelled, you may roll the funds back into an IRA. You have 120 days from the date of the distribution to do this, rather than the normal 60-day deadline for rolling over IRA distributions.
Claiming the Exception
Your IRA distribution will still be taxable to you, unless you have basis included in the distribution, so be sure to report it on your tax return. This tax break only gets you out of the 10% early distribution penalty. Your IRA custodian will likely report the distribution as an early distribution to both you and the IRS. You will need to claim the exception to the 10% early distribution penalty on Form 5329. You will file this form with your tax return for the year. As with all tax matters, you will want to keep good records in case the IRS decides to ask questions.
By Sarah Brenner, JD
Director of Retirement Education
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.