Can I use My IRA to Buy a Home?

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Question:  Can I use my traditional IRA and Roth IRA to buy a house, which I would occupy as my primary residence?  Would there be penalties and taxes?

Answer:  Even though home prices have recovered somewhat over the few years, it might still be a good time to buy a house.  Mortgage interest rates have remained at historic lows.  If you are under the age of 59 ½, you will pay a 10% penalty on the taxable portion of withdrawals from a traditional IRA--unless you meet one of the penalty exceptions.

One of those exceptions is a withdrawal of up to $10,000 to buy, build, or rebuild a “first home.” The same penalty and exception applies to withdrawals of earnings from a Roth IRA.  However, the $10,000 is a cumulative lifetime limit that applies to all your IRA accounts.  You can’t withdraw $10,000 penalty-free from your traditional IRA and another $10,000 penalty-free from your Roth IRA. 

The IRS considers you as a first-time homebuyer if you have not owned a home for at least two years.

Any money you withdraw from a traditional IRA is taxed except for your “basis” in the IRA.  Your basis is the amount that you contributed that you could not deduct on your tax return when you made the IRA contribution..  You keep track of your basis on IRS Form 8606.  When you make a withdrawal, you prorate it to find the taxable and nontaxable amounts.  For example, if you have $50,000 in your IRA with a $10,000 basis, 20% of your withdrawal is non-taxable.  If you withdrew the entire $50,000, you would pay tax on $40,000.  If you were under 59 ½, you would also pay a 10% penalty on $40,000.  If you used the money for a first-time home purchase, you would pay taxes on $40,000 and a 10% penalty on $30,000.

The rules for taxing withdrawals from Roth IRAs are different.  You won’t pay any tax or penalty on a qualified withdrawal, which is defined as a withdrawal after you meet a five-year holding period that starts on the first day of the first year during which you first made a Roth IRA contribution and you were either 59 ½ or older, or the distribution is due to death or disability, or the distribution is eligible for the first-time homeowner exception to the 10% penalty tax on early distributions. 

Withdrawals from Roth IRAs are not pro-rated like they are for traditional IRAs.  Withdrawals are considered to come first from contributions and then from earnings.  No income tax or penalty applies until total withdrawals exceed total contributions (except in the case where the money was from an IRA conversion within the last five years). 

As an example, let’s assume you have contributed $20,000 to your Roth IRA and it has grown to $24,000.  Since distributions are not taxed to the extent they represent a return of contributions, you can withdraw $20,000 tax and penalty free.  If you withdrew the entire $24,000 you would owe income tax on $4,000 and a $400 penalty (no penalty if you used the money for a first-time home purchase).

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor 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 ken@montereypw.com.