Tax Court Limits IRA Rollovers

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Question: I understand that I can borrow money from my IRA account without paying taxes or penalties.  When do I have to pay it back?

Answer: The Internal Revenue Code says that you do not have to include any amount distributed from your IRA account in your taxable income if you pay the money back into your IRA account no later than 60 days after you receive the distribution.  The code further says that you are permitted to make only one such IRA rollover in any 1-year period.

Question: Why would anybody want to borrow money from their IRA for only 60 days?

Answer:  It is a fairly common practice if you need free cash for less than 60 days.  It gives you a way to borrow cash short-term without paying interest or going through the tedious process of applying for a loan.  You might want cash to make a down payment on a new house if you are selling your current home and expect the sale to close within 60 days.  Or you might need to buy a car and you know that within 60 days you will receive cash from the sale of another asset, from a bonus at work, or as a gift.  Or you might need a short-term loan to fund an important business transaction.

Question:  I have two IRA accounts.  Can I borrow money from each account and avoid taxes and penalties if I pay it back within 60 days?

Answer: Yes, but thanks to a recent Tax Court ruling, only until the end of this year.  It has long been common practice in financial planning circles to recommend to clients that if they plan to borrow money from an IRA, they should separate their IRA into two or more accounts and borrow the money they need from one account, leaving the second account available for another 60-day loan. The latest version of IRS Publication 590, “Individual Retirement Accounts” published on January 4, 2014, says that if you make a tax-free rollover from any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA or from an IRA into which you made the tax-free rollover. 

Publication 590 then gives an example in which you have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover from IRA-1 into a new traditional IRA IRA-3.  It goes on to say that you can still make a tax-free rollover from IRA-2 because you haven’t made a tax-free rollover in or out of IRA-2 within the last year. 

But despite what the IRS says in Publication 590, a recent Tax Court ruling held that the IRA rollover limitation applies on an aggregate basis, meaning that you can only make one 60-day rollover per year regardless of how many IRA accounts you have.  The IRS says it will adopt this Tax Court interpretation of the law and make changes to its regulations and to Publication 590, but that the revised regulations won’t take effect until January 1, 2015. 

If you plan to move IRA money from one IRA account to another, do a direct transfer.  It doesn’t count as a rollover.

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to ken@montereypw.com.