In most cases, the Internal Revenue Service discourages withdrawals from your traditional individual retirement account before you turn 59 1/2. However, you can get a break if you're using the money to buy your first home. If you qualify, it won’t make the distribution tax-free, but it will get you out of the early-withdrawal penalty.
The quirky IRS definition of a “first-time homebuyer” for the purposes of the IRA exception might allow you to qualify when you wouldn’t expect to, or it might disqualify you even if you’ve never had your name on a deed. You must not have owned a home in the two years prior to the purchase date for your new home. If you’re married, your spouse also has to meet the requirements.
For example, if you owned a home six years ago but have been renting ever since, you’re qualified. However, if you’ve never owned a home but your spouse sold her old home one year ago, you don’t qualify.
To use the first-time homebuyer exception, you don’t have to do anything fancy when you’re requesting the distribution from your traditional IRA, because you can get the money out at any time and for any reason. However, you do have to use the money for qualified costs within 120 days of taking the distribution. If you don’t, the distribution doesn’t qualify for the exception.
Qualified costs include not only the payment to buy the home, but also any mortgage fees or other financing costs. In addition, you’re limited to using the exception for no more than $10,000 of expenses over your lifetime. Anything over the limit is considered just an early withdrawal. However, if you’re married, each spouse can take up to $10,000, for a total of $20,000 as a couple.
When you file your taxes, you have to use Form 5329 to note you’re using the money for a first-time home purchase. Next to line 2, write the code “09” to indicate the exception. On line 2 write the amount of your distribution, up to your lifetime limit, that qualifies for the exemption. As long as your traditional IRA doesn’t exceed the lifetime limit, you won’t owe a penalty.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."