Using IRA money to fund things other than retirement can become more and more tempting as the balance in the account grows. Buying a residence is a significant expense and an integral part of the American Dream. To be clear, you cannot ever take money out of a traditional IRA without incurring income tax liability. To avoid paying any tax on a real estate purchase, you must turn to your Roth IRA account. Keep in mind that you can withdraw Roth principal at any time without tax consequences.
Make sure the withdrawal is for a first-time homebuyer. The IRS defines a first-time homebuyer, for these purposes, as someone who has not owned a home in two years. So, for example, if you owned a home in 2008, but sold it in 2009, you'd have been eligible for the first-time homebuyer exception by 2010.
Confirm that the property is a primary residence. Vacation homes and investment property do not meet the test.
See that the purchase is for a family member. The first-time homebuyer must be you, your spouse or a direct descendant or ancestor of one of the two of you. This includes the children, grandchildren, parents and grandparents of you or your spouse.
Withdraw no more than $10,000 in earnings from your Roth IRA if you have not yet reached 59 1/2. Before that age, you can take from a Roth IRA up to $10,000 in earnings once in your lifetime to buy a first home without incurring a tax penalty for early withdrawal. After you reach 59 1/2, as long as the account has been open for at least five years, you can withdraw any amount without tax. If you take out more than $10,000 in earnings after age 59 1/2, and the account has not met the five-year test, you will owe income tax on the amount that exceeds $10,000. Since you have already paid the taxes on any principal contributions to your Roth IRA, you can withdraw any part or all of it at any time without incurring any tax consequences.
Use the money for the purchase within 120 days of receiving it. It's prudent to make your withdrawal as close as possible to the anticipated closing date. However, if the closing is somehow delayed, and you see that you will miss the 120-day deadline, the IRS does allow you to put the money back into your IRA before the 120th day without tax or penalty. You can then take the money out again when the purchase does finally close. If you neither use nor redeposit the first-home funds within 120 days, you will owe any applicable taxes and penalties on the amount.
- When it comes to Roth principal calculations, the IRS sees all Roth IRA accounts as one. So if you have $30,000 in contributions spread over a number of accounts, you can take $30,000 from any one of those accounts, and it will be considered as principal and therefore not subject to tax or penalty.
- As mentioned, you pay income tax any time you take money out of a traditional IRA. However, if you buy a first home before age 59 1/2 with traditional IRA funds, you will escape the 10 percent penalty on the first $10,000 you withdraw.
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