Using 401(k) money to improve a home
Tax Talk by George Saenz

Dear Tax Talk,
I bought a foreclosed house, which I now live in. Prior to moving in, I replaced all of the second-floor carpet with hardwood, the second-floor laundry room and bathroom from vinyl to tiles plus new toilet, the first-floor dining area from carpet to tiles, the foyer from laminate to tiles, the kitchen from vinyl to tiles and the first-floor half bath got a new toilet and tiles instead of vinyl.

The only flooring that stayed was the living room laminate. All interior and exterior surfaces were also repainted. All these were paid for by some savings and zero-to-4.7 percent credit cards, but now the rate has gone up before I could repay. I want to use a loan from my 401(k) to pay the credit cards and my provider wanted me to check and make sure that I will not be in trouble if I get audited.

On their end, they can provide the money and need no paperwork from me. I have kept all the receipts and am prepared to show it to the IRS if an audit happens. Am I going to be violating any tax laws by getting the residential loan from my 401(k) and paying the credit card amounts that were used for home improvement? Please advise. Many thanks.
-- Anita

Dear Anita,

If a qualified plan such as a 401(k) permits a participant to borrow money, that loan generally must be repaid in substantially level periodic payments (at least quarterly) within five years. An exception to the five-year repayment rule (which I think is what you're asking) is a loan to purchase your main home. You can borrow from your 401(k) to purchase your main home and can take longer than five years to repay the loan, although you still have to make level periodic payments. The plan loan does not have to be secured by the home in order to obtain the longer repayment period.

Extended-payment plan loans are intended for the acquisition of the home and not for its improvement. Prior to amendment in 1986, plan loans for substantial improvement qualified for extended payment terms, but in the interest of simplification this provision was eliminated.

However, you can still use a five-year plan loan (i.e., not a residential loan) to cancel your credit card debt and I hope repay it in that time or be able to borrow against the increased value of the home at that time.