Can You Use an IRA for a House Down Payment?

An Individual Retirement Arrangement, or IRA, is a tax-advantaged savings account designed to help individuals save for retirement. The primary purpose of an IRA is to provide financial support during these years, and rules are in place to encourage funds to remain in the account until that time.

While these funds are earmarked for retirement, specific exceptions exist that allow for early access without the usual penalties. One of the exceptions is for purchasing a home.

The First-Time Homebuyer Penalty Exception

The Internal Revenue Service (IRS) provides an exception to the 10% early withdrawal penalty for those under age 59½ who use IRA funds for a home purchase. This allows an individual to withdraw a lifetime maximum of $10,000 from their IRA without this penalty. If you and your spouse are both first-time homebuyers, you can each withdraw up to $10,000 from your IRAs for a total of $20,000.

The IRS definition of a “first-time homebuyer” is broad. A person qualifies if they have not owned a primary residence at any time during the two-year period ending on the date the new home is acquired. This means you may be eligible even if you have owned a home in the past. Your spouse must also meet this two-year requirement.

The withdrawn funds are not limited to your own home purchase. The money can be used for qualified acquisition costs for a principal residence for yourself, your spouse, your children, grandchildren, or ancestors. These costs can include the down payment, closing costs, and financing fees related to buying, building, or rebuilding the home.

Tax Consequences of the Withdrawal

Traditional IRA

Withdrawing from a Traditional IRA for a home purchase has direct income tax consequences. While you avoid the 10% early withdrawal penalty on up to $10,000, the amount withdrawn is still considered taxable income. Contributions to a Traditional IRA are made with pre-tax dollars, so you received a tax deduction when you put the money in.

The withdrawn amount is added to your gross income for the year and taxed at your ordinary income tax rate. This can push you into a higher tax bracket, so you must account for federal and any applicable state income tax when calculating how much you will net from the withdrawal.

Roth IRA

Withdrawals from a Roth IRA for a home purchase follow specific ordering rules. The first dollars taken out are a return of your original contributions. Since Roth IRA contributions are made with after-tax money, this portion of the withdrawal is free of both taxes and penalties.

After you withdraw all contributions, subsequent withdrawals are sourced from earnings. For a distribution of earnings to be qualified and tax-free, you must have held a Roth IRA for at least five years. If this five-year rule is met, up to $10,000 of earnings withdrawn for a first-time home purchase is tax-free.

If the five-year rule is not met, the earnings portion of the withdrawal will be subject to income tax. However, you can still use the first-time homebuyer exception to avoid the 10% penalty on that amount.

Required Documentation and Tax Reporting

When you take a distribution from your IRA, your financial institution will send you Form 1099-R. This form reports the total withdrawal amount to you and the IRS, and Box 7 will contain a code indicating the reason for the withdrawal.

To claim the exception to the 10% early withdrawal penalty, you must file Form 5329 with your federal income tax return. On this form, you will report the total distribution and enter the amount that qualifies for the first-time homebuyer exception.

If you take a distribution from a Roth IRA or have made non-deductible contributions to a Traditional IRA, you may also need to file Form 8606. This form is used to track your basis, which is the amount of after-tax money you have contributed, to determine the taxable portion of any distribution.

The Withdrawal and Purchase Process

To use your IRA funds, first contact the custodian of your account, such as a bank or brokerage firm. You will need to follow their specific procedures for requesting a distribution.

The funds you withdraw must be used for qualified acquisition costs within 120 days after you receive them. The date of acquisition is the day you sign a binding contract to buy, build, or rebuild the home, not the closing date. If the home purchase is delayed or canceled, the funds can be returned to an IRA within this 120-day period. This rollover avoids any income tax or penalties on the distribution.