Normally, when you’ve put money into an IRA (or 401(k), or other deferred compensation arrangement), you are allowed to begin taking withdrawals once you’ve reached age 59 1/2. But sometimes you’d like to take your money out earlier… and you’ve probably already discovered that there is a 10% penalty for taking funds out of your IRA early, right? So – is there a way to avoid that penalty? Perhaps as a first time homebuyer.
There are several ways to withdraw IRA funds without penalty, as a matter of fact. There are several sections of the Internal Revenue Code that deal with these early distributions – including 72(t) (which we’ll cover in depth in another post), first time homebuyer, high medical expenses (including medical insurance), disability, and others. We’ll explain the first time homebuyer option in this post, and cover the remainder of the exceptions in other posts.
First Time Homebuyer
If you are buying, building, or re-building your first home (defined later), you are allowed to take a distribution of up to $10,000 (or $20,000 for a married couple) from your IRA to fund a portion of your costs, without paying the 10% penalty. There are a few restrictions, though – here is the official wording from the IRS:
- It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.
- It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following.
- Your spouse.
- Your or your spouse’s child.
- Your or your spouse’s grandchild.
- Your or your spouse’s parent or other ancestor.
- When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.
If both you and your spouse are first time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.
Qualified acquisition costs. Qualified acquisition costs include the following items.
- Costs of buying, building, or rebuilding a home.
- Any usual or reasonable settlement, financing, or other closing costs.First time homebuyer. Generally, you are a first time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.
Date of acquisition. The date of acquisition is the date that:
- You enter into a binding contract to buy the main home for which the distribution is being used, or
- The building or rebuilding of the main home for which the distribution is being used begins.
The keys here are to make sure that you qualify as a first-time homebuyer (by the IRS’ definition above), that you use the funds in time (before 120 days has passed), and that you haven’t taken this option previously. For many folks this can be very helpful in funding the purchase of a home.
Another important point here is that you need to understand that although you do not have to pay the 10% penalty on the distribution, you WILL be required to pay ordinary income tax on any money taken from your IRA. This can be a surprise to some folks who weren’t expecting it.