Tapping an IRA to buy; clarifying home-sale loss

A couple of questions have popped up more than once in the past several weeks, a good indicator it’s time to clarify.

First, can you withdraw from your Individual Retirement Account for a down payment on a home and not face a premature-withdrawal penalty? The answer is no, unless you are a first-time homebuyer, but many consumers are mistakenly under the impression they can.

Misinformation given by local Internal Revenue Service offices has added to the confusion. According to a federal tax-court case, a couple was charged for withdrawing their IRAs to buy a home even though their local IRS public-assistance representative said the funds would not be taxable.

Emma and James Clarke each withdrew $16,000 from their IRAs. They wanted to be certain the amounts were not taxable because the Clarkes said they would not be able to purchase the house and pay taxes on the $32,000 withdrawal. According to the Clarkes, they were told no penalty would be assessed.

The court ruled that when IRS employees give incorrect interpretations of the law, the IRS is not bound by that advice. In fact, the IRS is not generally bound by the language of its own publications. The court ruled the Clarkes’ withdrawals were taxable under the rules that generally apply to IRA distributions.

The first-time buyer limit on IRA withdrawals is $10,000. Both you and your spouse can qualify individually for the homebuyer exemption. That means each of you can withdraw $10,000 without penalty, doubling the amount of available IRA cash.

According to Charles Schwab, the $10,000 limit is set in stone if you have a traditional IRA. However, if you have a Roth IRA that you’ve held for more than five years, you can withdraw contributions to a Roth tax- and penalty-free. Earnings, however, withdrawn from the Roth, are subject to the $10,000 limit.

The IRS definition of first-time homebuyer is not necessarily synonymous with “young.” Consumers do not have to be purchasing their first principal residence. Under the tax rules, consumers qualify as long as they (or their spouse) didn’t own a principal residence at any time during the previous two years.

n fact, you can even share your IRA wealth. The IRS says the first-time homebuyer using IRA funds for a down payment can be the account owner, spouse, child, grandchild or a parent.

According to accountants, not only do some people assume they can use their IRAs for home purchase because other retirement funds are eligible, but they also mistake the guidelines involved. It’s important to determine when you plan on closing on the home sale and not take out the funds too soon. The account holder must use the IRA funds within 120 days of withdrawal to pay qualified acquisition costs. This includes the costs of buying, building or rebuilding a home, along with any usual settlement, financing or closing costs.

The second topic needing clarification is the financial loss incurred when selling a home. There is no relief or tax deduction for selling your home for less than its purchase price, classified as a capital loss.

Why? The principal residence has always been viewed as a personal asset. The gain on the sale of a principal residence has been taxable as a capital gain but losses have never been allowed. Although the capital gain thresholds have been increased, proposals to address capital losses have been defeated.

The net result is that there still is no benefit for folks who bought at the peak of the market or made expensive remodels, then sold and got less for their home than the cash they have invested in it. Long-term capital expenditures usually pay off over time, but changes for the short term are difficult to recover.

If you are still “underwater,” you are not alone. The good news is that many neighborhoods are appreciating faster than expected, perhaps putting you in positive territory sooner rather than later.

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