Can You Use IRA Money to Buy a House?

An Individual Retirement Account (IRA) is a specialized savings vehicle designed to help individuals accumulate funds for retirement. These accounts offer specific tax advantages, with contributions potentially being tax-deductible or growing tax-free, depending on the IRA type. While IRAs encourage long-term savings, accessing these funds before a certain age can lead to financial consequences, including penalties and taxes. This article explores the specific circumstances under which IRA funds can be utilized for a home purchase.

General Rules for IRA Withdrawals

Withdrawing money from an IRA before reaching age 59½ typically results in a 10% early withdrawal penalty imposed by the IRS. This penalty applies unless a specific exception is met. For Traditional IRAs, the withdrawn amount is also subject to ordinary income tax, as contributions are often made with pre-tax dollars.

For Roth IRAs, contributions can generally be withdrawn tax-free and penalty-free at any time. However, earnings withdrawn before age 59½ are usually subject to both income tax and the 10% penalty. These rules highlight that IRAs are primarily intended for retirement savings, and early access comes with financial costs.

The First-Time Homebuyer Exception

A specific provision allows individuals to use IRA funds for a home purchase without incurring the typical 10% early withdrawal penalty. This is known as the first-time homebuyer exception. To qualify, an individual must not have owned an interest in a main home during the two-year period ending on the date of acquisition of the new home. If married, both spouses must meet this requirement for the exception to apply to joint funds.

Under this exception, an individual can withdraw up to $10,000 from their IRA penalty-free over their lifetime. This is a lifetime cap per individual. If both spouses qualify and have their own IRAs, they could each withdraw up to $10,000, totaling $20,000 for a shared home purchase. The funds must be used for qualified acquisition costs, which include buying, building, or rebuilding a principal residence, along with usual settlement and financing costs.

The withdrawn funds must be used to acquire a home within 120 days from the date of withdrawal. If the home purchase is delayed or cancelled, the funds can be rolled back into an IRA within this 120-day period to avoid penalties. While the 10% penalty is waived for both Traditional and Roth IRAs under this exception, the taxability of the distribution still depends on the IRA type. For a Traditional IRA, the withdrawn amount remains subject to ordinary income tax.

For Roth IRAs, if earnings are withdrawn for a first-time home purchase, they can be both tax-free and penalty-free, provided the Roth IRA has been established for at least five years. If the five-year rule is not met, earnings withdrawn under this exception would still be subject to income tax, though the 10% penalty would be waived.

Using Roth IRA Contributions for a Home

Roth IRAs offer a unique advantage for accessing funds beyond the first-time homebuyer exception. A fundamental feature of Roth IRAs allows for the withdrawal of contributions at any time, for any reason, without incurring taxes or penalties. This is because contributions to a Roth IRA are made with after-tax dollars, meaning the taxes have already been paid. Consequently, these principal contributions are always accessible to the account holder.

For instance, if an individual has contributed $20,000 to a Roth IRA, they can withdraw that amount at any point, regardless of their age or the account’s duration, to use for a home purchase or any other need, without tax or penalty. This differs significantly from withdrawing Roth IRA earnings, which generally require the account to be at least five years old and the owner to be 59½ or older for qualified, tax-free, and penalty-free distributions.

Withdrawing and Reporting IRA Funds for a Home

To withdraw IRA funds for a home purchase, individuals typically contact their IRA custodian, the financial institution holding the IRA. The custodian will provide instructions and may have specific forms to complete for the distribution. It is important to clearly communicate the purpose of the withdrawal.

Accurate tax reporting is essential when taking an early IRA distribution and claiming an exception. The IRA custodian will issue Form 1099-R, reporting the distribution amount. When filing federal income taxes, individuals must indicate that the distribution qualifies for an exception to the 10% early withdrawal penalty, often using specific codes on tax forms.

Maintaining thorough documentation is important to substantiate eligibility for the first-time homebuyer exception if the IRS inquires. This documentation could include the home’s purchase agreement, settlement statements, and other records proving the funds were used for qualified acquisition costs within the 120-day timeframe. These records serve as proof that the withdrawal met IRS requirements for penalty avoidance.