Individual retirement accounts offer significant tax advantages, but with those advantages come some limitations on how you can invest and use the money. Though buying a French chateau or a Spanish villa might sound like a great purchase for your IRA funds, you can't always do it without incurring penalties from the Internal Revenue Service.
Foreign Property Investments
There's nothing in the IRS rules that explicitly prohibits buying foreign property as an investment in your IRA. For example, if you think the price of land in the Swiss Alps is going to go through the roof, knock yourself out investing in it. However, don't think that your "investment" can double as a vacation home. The IRS prohibits you from using investments in your IRA, such as foreign property, for personal use, even in the future. For example, if you do buy that land in the Swiss Alps, you and your family can't use it for a vacation home as well.
Prohibited Investment Penalties
If you engage in a prohibited transaction in your IRA, such as using foreign property for personal use, your entire IRA is treated as being distributed on January 1 of that year -- even if the foreign property is only a small portion of the account. The account value is taxed as a permanent distribution from the IRA. Worse, if you aren't able to take qualified withdrawals yet, the taxable portion of the distribution gets slapped with an additional 10 percent tax penalty.
Once you take the money out of your IRA, the IRS doesn't care how you spend it -- at least for determining IRA penalties. If you have a traditional IRA, you can take your money out without penalty once you've turn 59 1/2 years old. For Roth IRAs, you must also have had a Roth IRA open for at least five tax years. Your tax years start counting from January 1 of the first tax year you made your contribution, regardless of when you actually put the money in your account.
First-time Homebuyer Exception
If you're under 59 1/2 years old, there's still hope for getting your money out penalty-free. Uncle Sam allows a penalty exception for up to $10,000 used to buy a first home. To qualify as a first-time home buyer, you and your spouse, if you're married, must not have owned a home for the past two years. According to IRS Publication 590, there's no requirement that your new home be in the United States.
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