Congress designed individual retirement accounts to encourage long-term savings. Part of this encouragement is to allow you to deduct IRA contributions and let them grow tax-deferred. You must pay taxes on withdrawals and a 10 percent penalty on money you take out before age 59 1/2. However, the rules provide a penalty exception for buying your first home.
You can successfully document your qualifying IRA withdrawal by providing dated copies of the closing documents used for your home purchase in addition to a properly completed 1099-R.
Payments on Your First Home
The Internal Revenue Service defines a property as a "first home" if you haven't owned a home for two years. You must use the property as your main home. Over your lifetime, you can remove up to $10,000 penalty-free from your IRA to help buy, build or rebuild a first home, as of 2018. You can also use the money to pay financing and closing costs.
The home can belong to you or family members. You must enter into a binding contract or begin construction within 120 days of withdrawing the money or the IRS will treat it as a nonqualified distribution that is subject to taxes and penalties.
Exploring The Documentation Process
The normal sequence of home buying is to sign a binding purchase contract, receive your final mortgage approval and close on the property. You must sign the purchase contract within 120 days of your IRA distribution. The IRS may need proof of your home-buying exception. You'll need a dated copy of the contract and copies of the documents you sign at closing.
If your closing is delayed or cancelled, you can avoid taxes and penalties by rolling the distribution into the same or different IRA. If so, you'll want to sign a replacement purchase contract so you can restart the 120-day countdown.
Completing Your Tax Reporting
Your custodian issues Form 1099-R for any year you take a distribution from your IRA. The form has a distribution code that your custodian should set to "2" to indicate an exception applies. Sometimes custodians don't enter the correct distribution code.
This shouldn't be a problem, because you must file Form 5329 with your tax return, indicating the early distribution is exempt from penalty. Enter the exception number and amount on the form. The exception number for first-home distributions is "09." You should also contact your IRA custodian and have a corrected Form 1099-R issued.
Assessing Other Important Considerations
Roth IRA contributions aren't deductible, but you can take qualified distributions tax-free. Withdrawals of contributions are always qualified distributions. However, if you remove your investment earnings before the fifth anniversary of your initial contribution or before age 59 1/2, the IRS will apply taxes and penalties. You can avoid these by withdrawing only your contributions.
The IRS won't tax or penalize earnings withdrawn before 59 1/2 that meet the requirements for the first home exception. However, it will penalize any earnings you remove during the initial five years. Report Roth distributions on Form 8606, indicating the amount you used for a qualified first-time home purchase.
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