Can I Use My IRA for a Down Payment on a House?

Using funds from an Individual Retirement Account (IRA) for a home down payment is a possibility under specific Internal Revenue Service (IRS) regulations. While IRAs are designed for retirement savings, the tax code provides an exception for homebuyers, allowing access to these funds for a significant purchase without incurring the usual early withdrawal penalties.

The ability to use retirement funds in this manner is governed by a distinct set of rules that vary based on the type of IRA and the individual’s circumstances. Navigating these requirements is necessary to ensure the withdrawal is executed correctly and to avoid unexpected tax consequences. Understanding the specific guidelines for what constitutes a qualified expense and who is considered an eligible homebuyer is the first step in this process.

The First-Time Homebuyer Exception

The tax code allows for a penalty-free withdrawal from an IRA for a home purchase, but it is subject to a lifetime limit of $10,000. If a married couple both have IRAs and both qualify as first-time homebuyers, each spouse can withdraw up to $10,000 from their respective accounts, for a combined total of $20,000.

A central component of this rule is the IRS definition of a “first-time homebuyer,” which is broader than the term suggests. An individual qualifies if they have not owned a principal residence at any point during the two-year period ending on the date the new home is acquired. If the individual is married, their spouse must also meet this requirement for them to be eligible.

The rules also permit the IRA holder to use the funds for a qualifying family member. The distribution can be made to assist a spouse, child, grandchild, parent, or another ancestor in purchasing their first home. In this scenario, the family member receiving the funds must meet the first-time homebuyer criteria. The IRA owner making the withdrawal does not need to be a first-time homebuyer themselves if the funds are for an eligible relative.

These funds are designated for “qualified acquisition costs,” which include the costs of buying, building, or rebuilding a home. This encompasses the down payment, closing costs such as attorney fees and title insurance, and other settlement expenses. The funds must be used toward a principal residence, which is the home the individual will live in, not a vacation home or an investment property.

Withdrawal Rules for Different IRA Types

Traditional IRA

While the first-time homebuyer exception allows an individual to withdraw up to $10,000 without the 10% early withdrawal penalty, the amount withdrawn is still subject to income tax. This is because contributions to a Traditional IRA are typically made with pre-tax dollars, meaning taxes have not yet been paid on that money.

The withdrawn amount is added to the individual’s gross income for the year and is taxed at their ordinary income tax rate. This can potentially push the individual into a higher tax bracket, resulting in a larger overall tax liability for that year.

Roth IRA

Withdrawals from a Roth IRA for a first-time homebuyer follow a strict ordering rule. Withdrawals are always considered a return of your direct contributions first. Because contributions are made with after-tax dollars, they can be withdrawn at any time, for any reason, completely tax-free and penalty-free.

After all contributions have been withdrawn, you can then withdraw earnings. For a first-time home purchase, you can withdraw up to a lifetime maximum of $10,000 in earnings without the 10% early withdrawal penalty.

Whether this withdrawal of earnings is also tax-free depends on the five-year holding period. If you have held any Roth IRA for at least five years, the earnings are not subject to income tax. If the five-year period has not been met, the earnings portion of the withdrawal will be subject to ordinary income tax, though it remains exempt from the 10% penalty.

Required Information and Key Deadlines

The funds distributed from an IRA for a home purchase must be used for qualified acquisition costs within 120 days of receiving them. This 120-day clock starts on the day the individual receives the distribution from their IRA custodian.

If the home purchase is unexpectedly delayed or canceled, the funds can be returned to an IRA to avoid taxes and penalties. This repayment is treated as a rollover contribution and must be completed within the same 120-day window. Failing to use the funds or roll them over within this period will result in the distribution being treated as a standard early withdrawal, subject to both income tax and the 10% penalty.

To substantiate the use of the funds, individuals should maintain thorough documentation. This includes records of the IRA distribution, a signed contract of sale for the new home, and the settlement statement (often a Closing Disclosure or HUD-1 form) detailing the costs paid at closing. These documents serve as proof that the withdrawal was used for its intended purpose and within the required timeframe, which is important in the event of an IRS inquiry.

The Withdrawal and Reporting Process

The individual must contact the financial institution that serves as the custodian for their IRA. The custodian will have a specific procedure for requesting a distribution, which typically involves completing a withdrawal form. On this form, the individual will need to indicate the reason for the withdrawal to ensure it is coded correctly for tax reporting purposes.

After the distribution is processed, the IRA custodian will issue Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. This form reports the gross amount of the distribution to both the individual and the IRS. The code in Box 7 of Form 1099-R will indicate the nature of the distribution, but it is the taxpayer’s responsibility to claim the penalty exception on their tax return.

When filing their federal income tax return, the individual must complete IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts. The individual will enter the appropriate exception code on the form to show that the distribution is not subject to the 10% penalty. The taxable portion of the distribution, if any, is then reported as income on their Form 1040.