Can You Use Your IRA to Buy a House?

It is possible to use funds from your Individual Retirement Account (IRA) to help finance a home purchase. This involves a specific exception to standard IRA withdrawal rules, often referred to as the “first-time homebuyer” exception. Understanding the conditions and requirements is important before proceeding.

Eligibility for Penalty-Free Withdrawals

Withdrawing funds from an Individual Retirement Account (IRA) before reaching age 59½ generally results in a 10% early withdrawal penalty from the IRS. However, federal tax law provides exceptions, including one for qualified first-time home purchases. This exception allows individuals to withdraw funds without incurring the penalty.

To qualify for this exception, an individual must meet the IRS definition of a “first-time homebuyer.” This definition is broader than simply purchasing a home for the very first time. An individual, along with their spouse if applicable, must not have owned a main home during the two-year period ending on the date of the acquisition of the new home. Someone who previously owned a home but sold it more than two years ago could still qualify under this provision.

The maximum penalty-free withdrawal under this exception is $10,000 over the individual’s lifetime. This $10,000 limit applies to each individual. If a married couple jointly purchases a home and both qualify, each spouse can withdraw up to $10,000 from their respective IRAs, totaling $20,000.

This first-time homebuyer exception applies to distributions from both Traditional and Roth IRAs. While the penalty is waived for both, the tax treatment of withdrawn funds differs significantly, which will be discussed in a later section.

Qualifying Home Acquisition Costs

The funds withdrawn under the first-time homebuyer exception must be used for specific “qualified acquisition costs” related to purchasing, constructing, or reconstructing a principal residence. These costs encompass more than just the direct purchase price of the home. They include various expenses directly associated with the transaction.

Specific examples of qualified acquisition costs include the costs of acquiring the home itself, such as the down payment and principal amount. They also extend to settlement costs, which are expenses incurred at the closing of the transaction. These can include attorney fees, title insurance, and recording fees.

Additionally, certain financing costs are considered qualified acquisition expenses. This may include loan origination fees, appraisal fees, and other charges directly related to securing the mortgage for the home. All these expenses must be clearly documented to substantiate their connection to the home purchase.

The home being acquired must serve as the principal residence for the individual, their spouse, their child, their grandchild, or a parent or grandparent. This requirement ensures the funds are used for a primary dwelling rather than an investment property or a vacation home. The emphasis is on establishing a main place of abode for the qualifying individual or their specific family members.

Timeline for Using Funds

A strict timeline governs the use of funds withdrawn from an IRA under the first-time homebuyer exception. The withdrawn amount must be used for qualified acquisition costs within 120 days of the date the distribution is received from the IRA. This 120-day window is a requirement for maintaining the penalty-free status of the withdrawal.

If the funds are not fully used for qualified acquisition costs within this 120-day period, any unused portion may become subject to the usual 10% early withdrawal penalty. This penalty applies if the individual is under age 59½ at the time of the distribution. Additionally, the unused portion will be treated as ordinary income and taxed at the individual’s regular income tax rate.

Therefore, careful planning and coordination are essential when considering an IRA withdrawal for a home purchase. It is advisable to time the distribution from the IRA to coincide closely with the anticipated closing date of the home acquisition. This minimizes the risk of the 120-day period expiring before the funds can be properly applied.

Failing to meet the 120-day rule can result in unintended tax consequences, negating the benefit of the penalty exception. Individuals should ensure they have a firm closing date and a clear understanding of all associated costs before initiating the IRA distribution. Proper timing helps ensure compliance with IRS regulations and avoids unnecessary penalties.

Tax Implications and Reporting

While the 10% early withdrawal penalty is waived for qualifying first-time homebuyer distributions, the taxability of the withdrawn funds depends on the type of IRA. For distributions from a Traditional IRA, the withdrawn amount is generally subject to ordinary income tax. This means the money is added to the individual’s taxable income for the year of the distribution and taxed at their marginal income tax rate.

In contrast, distributions from a Roth IRA receive more favorable tax treatment, provided certain conditions are met. A qualified distribution from a Roth IRA, including one for a first-time home purchase, is both penalty-free and tax-free. For a Roth IRA distribution to be qualified, the account must have been open for at least five years, a period known as the five-year aging rule. If the Roth IRA has not met this five-year requirement, only the original contributions can be withdrawn tax-free and penalty-free; any earnings withdrawn would be subject to income tax and potentially the 10% penalty if the individual is under 59½ and no other exception applies.

To properly report the penalty-free withdrawal on your tax return, you will receive Form 1099-R from your IRA custodian. This form reports the gross distribution amount. To claim the first-time homebuyer exception and avoid the 10% penalty, you must file Form 5329 with your federal income tax return.

On Form 5329, you will indicate the amount of the distribution that qualifies for the first-time homebuyer exception. This form essentially informs the IRS that your early withdrawal meets the specific criteria for penalty relief. The form helps reconcile the distribution reported on Form 1099-R with the claimed exception.

Maintaining thorough records is important to substantiate your eligibility for the exception and the proper use of the funds. This documentation should include closing statements from the home purchase, the purchase agreement, and any other receipts or proof of payment for qualified acquisition costs. These records serve as evidence in case the IRS requires verification of your claim for the first-time homebuyer exception.