Tax Ramifications of IRA Withdrawal For Home Purchase

If you’re a first-time home buyer and looking for ways to come up with a down payment on your home, you may be wondering if you can withdraw money from your retirement investments such as an individual retirement account (IRA) without incurring any penalties.

Typically, when you take money out of an IRA before you reach age 59 1/2, the Internal Revenue Service considers these premature distributions. In addition to owing any tax that might be due on the money, you may face a 10% penalty on the amount withdrawn. However, there are some exceptions to the general rule.

The IRS allows an exception for first-time home buyers. First-time home buyers are permitted to make early withdrawals from their IRA without incurring a penalty. However, there are limitations on the amount that can be withdrawn. Individuals are capped at a $10,000 withdrawal from their IRA to use towards a first-time home purchase. If you are married, each spouse can withdraw $10,000 from their IRA for a combined $20,000.

Additionally, “first-time home buyer” includes more than people who are buying their very first home. The IRS definition is broader and allows a withdrawal as long as you or your spouse have not purchased a home within the previous two years. There are also important time limitations on any IRA withdrawals that are made. Once an IRA withdrawal is made,  the funds must be used within 120 days.

It’s also important to note that Roth IRAs have a few different rules that apply to withdrawals from Roth IRAs compared to the Traditional IRA. Roth IRA withdrawals for home purchases require that the funds be held in the Roth IRA for five years. Further, since the taxes on Roth IRAs are pre-paid essentially, any gains in the Roth IRA are tax free if held for over five years.  In the event that funds are withdrawn prior to five years, the 10% penalty can be avoided, but any gains would be taxed.

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