How Do I Use a Traditional IRA for a First-Time Home Purchase?

by Mark Kennan, studioD

One of the few times the Internal Revenue Service lets you tap your traditional IRA early is to buy a first home. If you're over 59 1/2, your distribution is already qualified, so the first-time homebuyer exception won't offer you any additional benefits. However, if you're not yet 59 1/2, the exception can save you the 10 percent early withdrawal penalty on all or a portion of your distribution if you qualify.

First-Time Homebuyers

To be a first-time homebuyer for the purpose of the IRA early withdrawal exception, you can't have owned your primary residence for the last two years. If you're married, you're ineligible unless your spouse also qualifies. The two years counts from the date you sign a binding contract or start construction on the home. You can also use the exception to help a qualifying parent, grandparent, child or grandchild pay for the costs of a first home.

Qualified Costs

To qualify, your withdrawal must be spent on qualifying costs no more than 120 days after taking out the money. If you wait more than 120 days, you can't use the exception. Qualifying costs include both the cost of buying, building or rebuilding the home, such as a down payment, and the settlement or financing charges, such as your mortgage closing costs.

Withdrawal Limits

The IRS limits the first-time homebuyer exemption to just $10,000 over your lifetime. For example, if you used $8,000 on your first home and then wanted to help your daughter buy her first home, you could use the exception on only $2,000 of your distribution. However, the limit is separate for each spouse, so if you're married, you could use the exception for $10,000 from your traditional IRA and your spouse could use $10,000 from hers for a total of $20,000 in penalty-free withdrawals. The IRS doesn't prohibit you from taking out more than the lifetime limit, but if you do, the excess won't be exempted from the early withdrawal penalty.

Tax Reporting

Reporting the distribution on your taxes properly is critical so that IRS doesn't question your return. Like any other distribution from a traditional IRA, report the amount withdrawn as a taxable IRA distribution -- even if you are exempt from the penalties, you must pay income tax on any amounts you withdraw from your IRA. However, you also must file Form 5329 to note your use of the first-time home buyer exception. On Form 5329, write "02," the code for the first-time home buyer exception, next to line 2 to exempt your distribution from the penalty.

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About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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