Can you use IRA funds to buy a home?

QTA Consultants, Ltd./Renata Bliumaite

Suppose you can’t come up with all the cash needed for the down payment on your “dream house.” Think outside the box.

Strategy: Consider an IRA as a secondary source of funds. Although IRAs are intended to be used for retirement savings, tapping into your account might make sense if it helps to close the deal. The main advantage of this technique is that the distribution may be exempt from the usual tax penalty for early withdrawals.

Here’s the whole story: Normally, if you receive a distribution from an IRA prior to age 59½, a so-called early distribution, you must pay a 10% tax penalty, in addition to the regular income tax you owe. The 10% penalty is assessed on the taxable portion of the distribution (i.e., the pro rata amount representing deductible contributions and earnings). However, there are several key exceptions to this rule, including one for the first $10,000 of funds received by first-time homebuyers. The definition of a “first-time homebuyer” for this purpose is quite broad. It includes an individual who hasn’t owned a home as their principal residence for the past two years. Also, note that the IRA owner doesn’t have to be the homebuyer. For instance, you can take advantage of the exception to help purchase a home for your adult child. But the taxable portion of the distribution will be included in your taxable income and taxed at your rates. To qualify for the exception for so-called first time homebuyers, you must meet the following three requirements. 1. The distribution must be used to pay qualified acquisition costs within 120 days after the day you receive it. 2. The distribution must be used to pay qualified expenses for the principal residence of the eligible first-time homebuyer. Qualified expenses include acquisition costs (e.g., the down payment), the cost of building or rebuilding the home and any usual or reasonable settlement, financing or closing costs. 3. The $10,000 limit on the exception is a lifetime limit. If both you and your spouse are first-time homebuyers, each one of you can take an IRA distribution of up to $10,000 without owing the 10% penalty tax, as long as the distributions come from IRAs set up in your separate names.

Tip: Use this strategy judiciously.