Timing for an IRA Distribution for First Time Homebuyer Purchase
August 1, 2015 2:10 AM   Subscribe

"Consult your tax advisor about your particular situation. " Hmpf. As if everyone has a tax advisor at their fingertips. So... I thought MeFi would be just as helpful. :-) After lots of thought, we would like to take an early distribution from an IRA for the downpayment on a house. Anyone here on MeFi have any experience with or specific knowledge of this type of distribution? Not looking for advice on whether we should or shouldn't do this; we have a pretty good nest-egg and believe this distribution is for the right reason, at the right time.

The only information I've found online is that the distribution will be penalty free, but regular taxes will need to be paid for the year in which the distribution takes place.

The key is that the funds must be used for the specific purpose within 120 days of distribution to avoid the 10% penalty.

- At what point should I request the distribution? Do I have to have the funds/downpayment when I'm making the offer. Or do I make the offer with $7,500 ($10K-minus estimated taxes) to be paid at closing?

- What if the offer is rejected or if there is a delay in closing - Can I return/re-deposit the funds to the IRA to avoid the penalty?

How will this play out for our 2015 taxes?

Say we close on a house in Sept or October, we can deduct interest paid on the mortgage for the remaining part of the year - which won't be very much over a couple months. Would it be better to wait until early next year to make the purchase to take advantage of the higher amount of mortgage interest deduction over 2016 to bring us to a lower tax bracket? Or am I over thinking this.

We found a great house... and are seriously considering making an offer as early as next week.

Any insight would be greatly appreciated.
posted by funfunfun to Work & Money (5 answers total) 1 user marked this as a favorite
I would not make the distribution until a short time before closing. There are all kinds of things that can derail a purchase between offer and closing.

Depending on who the IRA custodian is, you could give it advance notice that you will be directing a distribution.

I would not let the timing of tax deductions on interest drive the timing of a home purchase decision.
posted by megatherium at 3:28 AM on August 1, 2015

One point slightly unrelated to your question is that you have used the pronoun 'we'. You and your spouse can each withdraw assuming you both have IRAs so you limit is actually $20K. Just in case you didn't know this.
posted by srboisvert at 5:46 AM on August 1, 2015

If you take a $10K distribution from your IRA, what fraction of that distribution will be taxed a higher rate than your current income? For example, if you're married and your taxable income (1040 line 43) is currently $70K, the 25% tax bracket kicks in at $73,800, so $6,200 would be taxed at the higher 25% rate, while the first $3,800 of your distribution would be taxed at the 15% rate. If your current income taxable income is $64,000, yes the IRA distribution will put you in a higher bracket, but this is also essentially irrelevant for determining your taxes, as only $200 will actually be taxed at the higher rate.

Figure out what your deduction (1040 line 40) will be with and without the mortgage interest. If you would take the standard deduction without purchasing the house, then only a portion of your mortgage interest will actually lower your tax.

You should fill out two versions of your 2015/2016 1040s, one assuming an IRA distribution in September, and one assuming the distribution is in January, while keeping your mortgage interest deduction the same so you can do an apples to apples comparison. Only this will allow you to quantify the benefit to taking the distribution with a full year of mortgage interest, and to weight it against the cost of foregoing a house you like.

As for logistics, your lender will want the funds in your bank account about 2 weeks before closing. You do not need to liquidate the assets at the time you make the offer. With a 45 day window between offer and closing, you will have a pretty good idea if the deal will actually go through by the point you need to liquidate the funds.
posted by deadweightloss at 5:56 AM on August 1, 2015 [1 favorite]

Here is another factor you need to consider:

If your down-payment is under 10,000. then would it be safe to assume that your mortgage will be for some amount smaller than 100,000.? If so, your mortgage interest may end up not being deductible because it's too low! The mortgage deduction benefits people with bigger mortgages quite nicely but does not help people who buy inexpensive houses.

"Under 26 U.S.C. ยง 163(h) of the Internal Revenue Code, the United States allows a home mortgage interest deduction, with several limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions must exceed the standard deduction (otherwise, itemization would not reduce tax)." Source.
posted by mareli at 7:05 AM on August 1, 2015 [1 favorite]

If your down-payment is under 10,000. then would it be safe to assume that your mortgage will be for some amount smaller than 100,000.?

Unless it's an FHA 203b. $7500 is 3.5% of $214k or so.

Your lender should be able to advise on the timing.

I would only caution you to make sure you know what you'll need to bring to closing if you haven't found out already. Cash due at closing (incl down payment, closing costs, and prepayments to escrow) can be double the costs of down payment alone in low-DP mortgages.
posted by supercres at 8:03 AM on August 1, 2015

« Older Moving on from past self-harm   |   What made your internships awesome? Newer »
This thread is closed to new comments.