Question: I have two IRAs, a contributory IRA worth $100,000 and a rollover IRA from a former employer’s 401k plan, also worth $100,000. I need $50,000 for a down payment on a new home. My current home is in escrow and is expected to close in 90 days. I know there is a rule that allows a taxpayer to withdraw money from his IRA and avoid tax and penalties if he puts it back within 60 days. My question is can I borrow $50,000 from my contributory IRA account now and in 59 days borrow $50,000 from my rollover IRA account to deposit into my contributory IRA to satisfy the 60 day rule, and then when my house sale closes in 90 days deposit $50,000 into my rollover IRA to avoid taxes and penalties?
Answer: This is a great strategy, and up until last year I would have said yes, as would have the IRS. In the IRS' Publication 590, they provide tax guidance for Individual Retirement Arrangement (IRA) holders. For the past 20 years through 2013, Publication 590 has given the following IRA rollover example:
“You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.”
In 2008, New York tax attorney Alvan Bobrow did something similar to what you want to do. He took distributions from two IRAs and replaced them each within 60 days. Contrary to their own guidance, the IRS challenged Bobrow, who took his case to tax court. He lost. The tax court ruled in January of 2014 that despite what the IRS Publication says, the Internal Revenue Code only allows a taxpayer to make one nontaxable rollover contribution in a year--regardless of the number of IRA accounts he has.
The bottom line is that beginning January 1, 2015, the popular practice of dividing your IRA up into several IRA accounts and making multiple 60-day rollovers is gone. The Bobrow ruling by the tax court is disturbing because it implies that you can’t rely on IRS guidance and that you need to go straight to the tax code to see what’s allowed. When Bobrow appealed, the Tax Court judge wrote, “Taxpayers rely on IRS guidance at their own peril,” and that IRS guidance isn’t “binding precedent” or sufficient “substantial authority.”
For what it’s worth, the IRS is bifurcating Publication 590 for 2014 and Publication 590-A will include new rules for rollovers.
So if you plan to make a rollover from an IRA account, first run it by your tax professional. Michael Jones, CPA, a partner in the accounting firm Thompson Jones in Monterey, says that “Rollovers, in which taxpayers take funds from their IRAs, are always dangerous. We see many requests for IRS private letter rulings involving relief from the 60-day rule.”
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, CA93940 or email them to firstname.lastname@example.org.