If you're a good saver, chances are you've got money socked away in an IRA. If it's time to buy a house, tapping your IRA for a down payment might be tempting. The good news is that, yes, you can use IRA funds for a home purchase. The bad news is that it's not especially straightforward. There are many things to consider, and some prohibited transactions to avoid.
Absolutely Not -- Prohibited Transactions
First things first: you cannot buy a home or create a down payment within the IRA itself, as an investment, if you are going to live there. The IRS prohibits IRA owners from buying property for personal use with IRA accounts. This type of transaction is completely prohibited, and the IRS will deem your IRA distributed -- null and void. This means you'll owe ordinary income tax on all untaxed money in your IRA, along with an additional 10 percent tax penalty if you're under age 59 1/2. This means that if you want to use IRA money for a down payment, you need to take a distribution.
Straight Distribution -- No Exception
You can withdraw money from your IRA at any time, but if you don't qualify for a normal distribution, you'll pay that 10 percent tax penalty on the withdrawal. This is in addition to ordinary income tax on any untaxed money -- traditional deductible contributions and all earnings in either traditional or Roth IRA accounts.
The IRS does allow a penalty exception for first-time homebuyers, and in this case the definition of "first time" is very liberal. You may withdraw up to $10,000 of IRA funds for a home purchase, penalty free, if neither you or your spouse has owned or had interest in a home for two years prior to the purchase of a new home. You can also use the money to build or rebuild a house, as long as it is a new purchase. You'll owe ordinary income tax on any untaxed money you withdraw.
Even if you don't qualify as a first-time homebuyer, other exceptions may allow you to use IRA funds for a down payment without incurring a tax penalty. Three specific exceptions may help: if you are over age 59 1/2, if you're disabled, or if you take substantially equal distributions from the IRA for a period of at least five years. If you have a Roth IRA, you may withdraw contributions penalty-free once the account has been open for five years. Rollovers and conversions also get exceptions once they've been in the Roth account for five years. IRS Publication 590 has a complete description of all penalty exceptions and reporting requirements.