Using IRA money to fund first purchase

[Account Closed]

I work for a bank and during IRA training today it was briefly brought to our attention that the IRS waives its 10% premature penalty on a Traditional IRA distribution if that distribution is used for a first home purchase for the IRA holder. I have a couple questions regarding this strategy:

a) What is the amount limit that you are allowed to withdraw without penalty? In class they approximated $10,000 but they aren't confident of this amount.

b) Does this strategy also exist for Roth IRAs and if so which plan type would be more beneficial to distribute from?

c) Could this strategy be implemented to fund the purchase of a 1-4 unit residential property if the IRA holder is an owner-occupant? Could this method be used together with an FHA loan?

d) Finally, how long must an owner-occupant live at the property before he is able to relocate and use the former property strictly as an investment?

Thank you so much in advance for your advice!

[Dmitriy Fomichenko]

@Account Closed

You are allowed to withdraw up to $10,000 to be used for the first time home purchase.

Contributions into Roth IRA have already been taxed, therefore those can be taken out without taxes or penalties, the earnings in the Roth IRA however would be subject to penalties and taxation if you take early distribution.

I believe you can buy multi-unit, as long as you buy it as owner-occupied, and yes, you can use FHA loan. You must occupy at least for one year, but I would double check with a lender.

Another alternative you may want to consider is buying investment property inside of your IRA. This way you are not taking any distributions, and are not allowed to live in the property, it must be used strictly as an investment. All of the income/gains/profits from the property will be tax-deferred or tax free in case of a Roth IRA.

[Account Closed]

Dimitriy, thank you for that reply and for taking the time to touch upon all of my questions!

I am particularly interested in learning more about the last point you'd made, namely buying investment property inside of my IRA. How exactly does that process work? If an IRA has been established and I locate property to purchase, how is the vesting established? Once the IRA is fully funded for the tax year, what becomes of the excess earnings from the property?

[Dmitriy Fomichenko]

@Account Closed

if your retirement account buys the property, the the title to the property is taken in the name of an IRA or 401k (not you). Therefore all of the income must go back into the account, it is not considered contribution, but simply return on investment. To help you understand think of the rental income form the property owned by your IRA in comparison of the dividends paid for the stocks you own by your IRA. In both cases those profits do not belong to you personally, but to your IRA, it must go back to your account sheltered from any taxes that you would pay otherwise if you own that asset personally.

[Dmitriy Fomichenko]

BTW @Account Closed , if you wish to 'mention' someone's name when replying on the post, type @ immediately followed by the persons name (w/o space) and then look for the name of that person to appear below. Select the name and when you post your comment, that person would be notified that his/her name been mentioned.

[Junaid Subzwari]

Hi @Dmitriy Fomichenko Thanks for the great information. Are the rules any different for using a SD IRA? It wasn't called out specifically, so I was curious to know if the rules are different for a traditional IRA vs. a SD IRA. Thanks!

[Dmitriy Fomichenko]

@Junaid Subzwari

in order to buy investment property in your retirement account, you have to have "self-directed" account. Which could be Traditional IRA, Roth IRA, SEP IRA, etc. (I would call them 'conventional' retirement accounts). Any of those accounts can be 'self-directed'.

So when comparing 'conventional' vs. 'self-directed', with conventional IRA or 401k, you have a custodian who dictates you where you can invest. With self-directed IRA or 401k, you have the freedom in invest as you wish (virtually anything, including real estate, precious metals, tax-liens, private business, mortgage notes, etc. the list is endless).

Hope this helps.

[Todd Michaels]

Originally posted by @Dmitriy Fomichenko:

@Account Closed

You are allowed to withdraw up to $10,000 to be used for the first time home purchase.

Contributions into Roth IRA have already been taxed, therefore those can be taken out without taxes or penalties, the earnings in the Roth IRA however would be subject to penalties and taxation if you take early distribution.

I believe you can buy multi-unit, as long as you buy it as owner-occupied, and yes, you can use FHA loan. You must occupy at least for one year, but I would double check with a lender.

Another alternative you may want to consider is buying investment property inside of your IRA. This way you are not taking any distributions, and are not allowed to live in the property, it must be used strictly as an investment. All of the income/gains/profits from the property will be tax-deferred or tax free in case of a Roth IRA.

 Hello @Dmitriy Fomichenko

Just to be clear about the Roth IRA to be used for a first time home purchase, you can use all of your contributions and up to $10,000 of earning tax/penalty free correct? This is assuming the Roth is at least 5 years old, under 59.5 years old, and for owner-occupant.

Thanks,

Todd

[Dmitriy Fomichenko]

@Todd Michaels

The rules for taking a distribution from a Roth IRA to finance a first-time home purchase are different than those for a traditional IRA. Remember that a withdrawal taken from a Roth IRA for the purchase of a first home is considered a qualified distribution after the account has been open for five tax-years. As such, any distribution taken from a Roth for that purpose and under those conditions will be both income tax- and penalty-free.

But remember that under the Roth distribution ordering rules, the first money out will be annual contribution money, which is never taxed or penalized. Next out would be conversion money, and that also would not be taxed or penalized provided it has been in the Roth for five tax-years. And last out would be earnings. Therefore, because of these distribution rules, that means the only money taken from a Roth IRA that might pose a problem would be either earnings or conversion money that has been in the Roth for less than five tax-years.

Disclosure: I'm not a CPA and this is not a tax or professional advice. I suggest you speak with qualified expert about your specific situation.