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Using an IRA for a down payment, tax-free

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Dear Real Estate Adviser,
Can I take money from my standard individual retirement account, or IRA, as a first-time homebuyer and not owe taxes on the distribution?
— A. Freeman

Dear A.,
While you can withdraw up to $10,000 from a traditional IRA or simplified employee pension, or SEP, IRA to fund a down payment for a first-time home purchase without paying the standard 10 percent early withdrawal penalty, you will still have to pay income tax on the distribution itself.

However, in a Roth IRA, a person can withdraw contributions (but not returns) at any point without penalty, either for first-time homebuying expenses or other expenditures. Here, we’ll proceed based on a withdrawal scenario involving a traditional IRA, since that appears to be what you have.

There are some qualifiers to contend with in getting that no-penalty tax treatment in your withdrawal from a traditional IRA. You must be younger than 59 1/2 years old, have not owned a house for at least two years and be withdrawing no more than $10,000, which is your lifetime limit. In other words, you won’t be able to raid your IRA for homebuying bucks again after you hit that threshold.

There are some other requirements to consider as well. The home you’re buying must be used for your principal residence, plus you’ll have just 120 days after withdrawing the IRA money to buy your house. Though that seems like plenty of buffer, make sure you time your IRA withdrawal just before your funding is due. A lot of “done” deals, particularly in purchases of short-sale homes, have been falling apart in this market or dragging along interminably.

By the way, you can also withdraw IRA money for a child or spouse who wants to buy a primary residence as a first-time homebuyer, using the same guidelines. It’s worth noting that if you’re able to pay back part or all of the IRA money within 60 days of removing them, a strategy called a “rollover,” then that portion would not be considered a distribution and won’t be taxed.

There is some potential downside to tapping into an IRA other than just the tax implications. The withdrawal obviously means that the chunk of IRA money you’re using can no longer be invested, plus the distribution of that money just might bump you into a higher tax bracket when it’s combined with other earned income. On the plus side, the $10,000 (or less) might contribute enough to your down payment to keep you from having to pay the dreaded private mortgage insurance, or PMI, payments over the course of your loan.

How you proceed will depend on your individual circumstances. Hence, I suggest you use a CPA or tax accountant when you’re tinkering with your IRA to make sure you’re proceeding prudently.

Good luck in your first-time home purchase!

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