Using 401K & Roth IRA to purchase second property

November 18, 2007 12:22 PM

Using 401K & Roth IRA to purchase second property ?? Is this possible ?? Any suggestions. Thanks, ek
posted by endlessknot to Work & Money (13 answers total)

Cashing in or borrowing against?

In any event, the tax consequences are so monstrous that I doubt this would be a good idea; you're looking at like a 40% early disbursal penalty for the 401K alone. That's a pretty significant hit. Even if you borrow against instead of cashing in, you're talking about having to reimburse pre-tax dollars with post tax dollars, which is another big hit.

Lacking more details, I can't see how this would be a god idea.
posted by mosk at 12:32 PM on November 18, 2007

er..."good" idea. Doubt it's a god idea either ;-)
posted by mosk at 12:33 PM on November 18, 2007

I believe this has been discussed in previous AskMe's.

With a 401K, no (unless you count borrowing from the 401K and then paying it back).

It is possible to purchase property with an IRA, but it is complicated and you absolutely cannot make any use of the property until after you retire. Essentially, you need to set up an arms-length investment vehicle to purchase the property, and then have your IRA invest in that investment vehicle, and if there's any appearance that you are getting current value (recreation, rental income, etc) from the property, you're busted big time. (I believe it is possible to have rental income, and have that rental income go into the IRA. But I'm not sure, and I'm also not sure whether you're allowed to be involved in managing the property.)

There are websites that cover this, but they look scary and scammy and involve having contracts written up by dubious lawyers.

In any case, you can't do it for the normal meaning of "second home," namely a home that you can go to on weekends and vacations.
posted by alms at 12:54 PM on November 18, 2007

When I purchased my home, I used my Roth/other retirement funds as collateral, but I did not have to cash them in. I don't know how that would factor in if it is not your primary residence. I think a better form of capital would be a home equity line on your existing primary residence, but in this market it might be overreaching. You don't want to risk your current home or your nest egg for a big maybe, you know?
posted by 45moore45 at 12:55 PM on November 18, 2007

It's possible, but it's a horrible idea.
posted by unixrat at 12:55 PM on November 18, 2007

sounds like a prohibited transaction to me, and I doubt you're going to create a IRS-compliant entity to enable this "arm's length" transaction.
posted by Mr_Crazyhorse at 1:10 PM on November 18, 2007

Response by poster: Thanks all.

The reason I asked was because there are new homes in Oxnard, CA just 1 mile from the beach.

****

I am wondering how will the commute from Oxnard to Santa Clarita will be:

1) I work in Santa Clarita and my wife works in Thousand Oaks. I want to live in Oxnard near the ocean for the weather.

2) How is the drive on the 126 ?

3) How is Oxnard as a place to live ? Is there a possibility if growth in the city economically ? Is this a beach town with future potential ?

4) Am I crazy to drive 45 miles each way ?

Thx.
ek
posted by endlessknot at 1:19 PM on November 18, 2007

I concur with alms. Generally, you can use IRA funds for any kind of investment, if you can get the custodian to approve it, but any kind of self-related transaction runs the risk that the IRS will characterize the use of the money as a withdrawal, triggering liability for income tax on the money and, if you are under age 59.5, a 10% penalty. The difficulty is that the line is vague and shifting, and it is not wise to take the chance that the IRS will disagree with your perception of where that line is.
posted by yclipse at 3:59 PM on November 18, 2007

With the Roth IRA, you can withdraw your contributions (but not your earnings) at pretty much any time without taxes or penalty since you already paid taxes on them. So taking money out of the Roth may well be an okay idea. However, you'll be forfeiting whatever you'd earn on your contributions, which historically averages 10-11%. If you can get a bank loan for a lower rate, do that. For a mortgage, the rate could actually be the same as or higher than your expected return and you'd still come out ahead due to the tax deduction, assuming your second property is deductible.

People will tell you that taking a loan against the 401(k) is bad because you have to pay it back with after-tax dollars. But if you borrow money from a bank, you have to pay them back with after-tax dollars too (except, of course, in the case of a mortgage). So it's a bad deal for something you could get a mortgage interest deduction on. For other types of loans, it may or may not be a better deal depending on the returns on your 401(k), which you will forfeit while the money is being paid back, and the loan interest rate (both the bank's offer and what you'd pay on a 401(k) loan). This is much more iffy but it could be a good deal in some circumstances, such as if you have bad credit.

Bottom line, if you will be using the second property for an additional residence and not as a rental, then all the mortgage interest on it is deductible, and so you should prefer a mortgage (even multiple mortgages) rather than a 401(k) loan, and you should also prefer it to a Roth withdrawal. If you'll be renting the second property, then it becomes a simple matter of who'll offer you the best rate.
posted by kindall at 6:54 PM on November 18, 2007

As kindall points out, there is nothing special about the fact that you have to pay back borrowed money to a 401k using after tax dollars. That's true for any loan.

The big risk about borrowing from a 401k is generally, if you quit or lose your job, you have to pay all the borrowed money back immediately. If you can't scrape up the money at short notice, you will be liable for all the taxes plus a 10% penalty. This might be a time when you can least afford the spare cash. That's a very risky situation.
posted by JackFlash at 8:47 PM on November 18, 2007

If it's your first home, you can deduct up to I think $11k or so out of an IRA tax-free (look it up, I used it four years ago to help with the downpayment on my first home). If I recall, the rules are really loose on what "first home" means.
posted by mathowie at 9:36 PM on November 18, 2007

I think $11k or so out

$10K lifetime limit, and for Roth IRAs at least the account has to have been established for 5 full tax years.
posted by Heywood Mogroot at 2:20 AM on November 19, 2007

Response by poster: Thank You everybody for clearing my doubts.

ek
posted by endlessknot at 9:07 PM on December 20, 2007