Suppose your recently graduated child wants to buy a starter home. You’d like to help out, but you don’t have extra cash. Strategy: Withdraw money from your IRA. Although the distribution is taxable, you can avoid the usual 10% early withdrawal penalty when funds are used for qualified first-time homebuyer expenses.
The maximum penalty-free lifetime withdrawal for this purpose is limited to $10,000 but is doubled to $20,000 if you are married and you and your spouse each withdraw $10,000 from your respective IRAs.
Here’s the whole story: Normally if you receive a distribution from an Ira prior to age 59 ½, you must pay a 10% tax penalty, in addition to the regular income tax you owe. The 10% penalty is assessed on the taxable portion of the distribution (i.e., the pro-rata amount representing deductible contributions and earnings).
However, there are several key exceptions to this rule, including one for the first $10,000 of funds used by a first-time homebuyer. The definition of a “first-time homebuyer” is quite broad. It includes an individual who hasn’t owned a home as his or her principal residence for the past two years.
Also, note that the home buyer doesn’t have to be the same person as the IRA owner. For instance, you can use your IRA funds to help purchase a home for your children, your grandchildren or your parents.
To qualify for the exception for the first-time homebuyers, you must meet the following requirements.
- The distribution must be used to pay qualified acquisition costs within 120 days after the day you received the payout.
- The distribution must be used to pay qualified expenses for the principal residence of the first-time homebuyer. Qualified expenses include acquisition costs (e.g., the down payment), the cost of building or rebuilding the home and any usual or reasonable settlement, financing or closing costs.
- The lifetime limit for this first-time homebuyer penalty exception is $10,000.
The same basic rules apply to early withdrawals from a Roth IRA.
Tip: IRAs are used primarily for retirement savings. When possible, replenish your account.
Small Business Tax Strategies