IRA For First Home Purchase
March 26, 2008 11:42 AM Subscribe
I want to buy my first house AND not owe any Federal taxes for 2007...Traditional IRA Perhaps?
So here is the deal, the Mrs and I want to buy our first house hopefully this summer, but Uncle Sam is trying to take a bite out of all the money we've saved up for a down payment (to the tune of almost $1000). I have this brilliant idea to lower our taxable income by each of us contributing the max to a Traditional IRA (like $4000, right?) knowing that we can withdraw it penalty free for a first time home purchase. I know we'll have to pay taxes on the $8000 in 2008, but since I'm going back to school starting in September, our tax bracket will be lower AND we'll own a home (hopefully), so it shouldn't hit us as hard. Other important info: this is in WA state. Combined 2007 income is less than $103,000.
Questions:
1. This plan sounds too good to be true...is it?
2. Assuming I move forward and each of us set up a Traditional IRA, is it possible to do so and not invest it anything knowing we plan on withdrawing the funds probably within the next 3 to 6 months?
3. I've got a mutual fund with TDAmeritrade already, should I stick with them to do the IRA or does it matter (worried about fees)?
So here is the deal, the Mrs and I want to buy our first house hopefully this summer, but Uncle Sam is trying to take a bite out of all the money we've saved up for a down payment (to the tune of almost $1000). I have this brilliant idea to lower our taxable income by each of us contributing the max to a Traditional IRA (like $4000, right?) knowing that we can withdraw it penalty free for a first time home purchase. I know we'll have to pay taxes on the $8000 in 2008, but since I'm going back to school starting in September, our tax bracket will be lower AND we'll own a home (hopefully), so it shouldn't hit us as hard. Other important info: this is in WA state. Combined 2007 income is less than $103,000.
Questions:
1. This plan sounds too good to be true...is it?
2. Assuming I move forward and each of us set up a Traditional IRA, is it possible to do so and not invest it anything knowing we plan on withdrawing the funds probably within the next 3 to 6 months?
3. I've got a mutual fund with TDAmeritrade already, should I stick with them to do the IRA or does it matter (worried about fees)?
Amounts you withdraw from your IRA are fully or partially taxable in the year you withdraw them.
posted by Merdryn at 12:16 PM on March 26, 2008
posted by Merdryn at 12:16 PM on March 26, 2008
Best answer: It took me a while to figure out that (I think) you're contemplating making a traditional IRA contribution now (before April 15) so that you lower your adjusted gross income for 2007. By withdrawing the money in 6 months or so for your house closing, it sounds like you will defer your taxes on $8,000 of income until tax year 2008.
IANAFP but this seems ok to me, albeit it seems like a lot of paperwork for what might not be that much in tax savings. Have you run the numbers to figure out exactly how much you'd save from this manuever? If you're going to be back in school in the fall, that's still 8-9 months of income, right? So it's not like you're going to have no income whatsoever for 2008.
posted by QuantumMeruit at 12:27 PM on March 26, 2008
IANAFP but this seems ok to me, albeit it seems like a lot of paperwork for what might not be that much in tax savings. Have you run the numbers to figure out exactly how much you'd save from this manuever? If you're going to be back in school in the fall, that's still 8-9 months of income, right? So it's not like you're going to have no income whatsoever for 2008.
posted by QuantumMeruit at 12:27 PM on March 26, 2008
Response by poster: Thanks all. I'll go home and run the numbers on Turbo Tax to see what our taxable incomes, less $8000, will actually mean as far reducing what we currently owe. If this saves us something like $300 then we'll probably go for it. But if it's a difference of $50....we'll probably won't even bother.
posted by Smarson at 12:36 PM on March 26, 2008
posted by Smarson at 12:36 PM on March 26, 2008
Sounds good to me, assuming you are correct that IRA withdrawals for a first-time home purchase are not penalized (I'll take your word on that). You can certainly invest it in a money-market fund in your IRA account so as not to risk the principal. Incidentally, I would not pay anyone for "actual financial" advice - this is not a big deal.
posted by thomas144 at 12:42 PM on March 26, 2008
posted by thomas144 at 12:42 PM on March 26, 2008
Agreed on "do the math"-- think about what the difference is in your marginal tax rate between 2007 and 2008. If you're married filing jointly, your 2008 AGI has to fall below $65,000 (including that $8000 you're pulling out of the IRAs) to be in the 15% bracket (rather than the 25% bracket you're currently in.) If you're not going to be able to do that, I don't think you're going to be saving any money by paying next year vs this year, just basically putting off the bill.
Plus keep in mind that there's a lifetime limit of $10,000 in withdrawals for home purchases (yes, you'd think that doesn't matter because you're only "first-time homebuyers" once, but actually you are "first time" if you haven't owned a home in the last two years, and you can also use it for relatives.)
posted by EmilyClimbs at 12:44 PM on March 26, 2008
Plus keep in mind that there's a lifetime limit of $10,000 in withdrawals for home purchases (yes, you'd think that doesn't matter because you're only "first-time homebuyers" once, but actually you are "first time" if you haven't owned a home in the last two years, and you can also use it for relatives.)
posted by EmilyClimbs at 12:44 PM on March 26, 2008
Response by poster: Thomas and Emily - Thanks for the reassurance. I'm definitely not going to pay for financial advice concerning this since we're talking about less than $10,000 for a one time non-investment and probably less than $500 saved in taxes.
As far as 2008 taxes, good point about having to be under the $65,000 mark for a bracket change. We might make that, but again, would be after 401K and other IRA deductions.
posted by Smarson at 1:01 PM on March 26, 2008
As far as 2008 taxes, good point about having to be under the $65,000 mark for a bracket change. We might make that, but again, would be after 401K and other IRA deductions.
posted by Smarson at 1:01 PM on March 26, 2008
Watch out for being audited, though. This sounds like something the IRS would disallow since you have an advance plan to do it. They might eliminate the IRA + withdrawal step and you might owe the taxes anyway plus penalties. If you do a transaction for the sole purpose of saving taxes, on audit the IRS can pretend it never happened or pretend that it happened the way the Internal Revenue Code meant it to happen.
The chances of you being audited are close to nil, and if you are audited you might have a decent argument on the merits (I can't say for sure since I don't know the law), but it's just something to keep in mind if that kind of thing bothers you.
posted by ohio at 1:19 PM on March 26, 2008
The chances of you being audited are close to nil, and if you are audited you might have a decent argument on the merits (I can't say for sure since I don't know the law), but it's just something to keep in mind if that kind of thing bothers you.
posted by ohio at 1:19 PM on March 26, 2008
If you do a transaction for the sole purpose of saving taxes, on audit the IRS can pretend it never happened or pretend that it happened the way the Internal Revenue Code meant it to happen.
Do you have a citation for this, ohio? I've never heard of this.
posted by Dec One at 1:25 PM on March 26, 2008
Do you have a citation for this, ohio? I've never heard of this.
posted by Dec One at 1:25 PM on March 26, 2008
Correcting EmilyClimbs: It's taxable income, not AGI, that determines your marginal tax rate. Taxable income is the number you arrive at after subtracting your personal exemptions and standard or itemized deductions from your AGI.
Here are the tax brackets for 2007 and 2008. The brackets are pretty wide, so you could have a pretty drastic change in income and still have the same marginal tax rate. If your marginal tax rate is the same for 2007 and 2008, then you'll save nothing on total taxes owed by doing your maneuver. However, you will put the tax on $8,000 off for a year, and that could easily be worth $100 in a high-interest savings account.
posted by Dec One at 1:32 PM on March 26, 2008
Here are the tax brackets for 2007 and 2008. The brackets are pretty wide, so you could have a pretty drastic change in income and still have the same marginal tax rate. If your marginal tax rate is the same for 2007 and 2008, then you'll save nothing on total taxes owed by doing your maneuver. However, you will put the tax on $8,000 off for a year, and that could easily be worth $100 in a high-interest savings account.
posted by Dec One at 1:32 PM on March 26, 2008
Response by poster: Ohio - Pretty sure the IRS is more concerned with the "letter" of tax code than the "spirit" of it. Everything is on the up and up here, so no reason they'd penalize me for it.
Dec One - Good point, except the whole reason for dropping the $8000 into a Traditional IRA in the first place is so that we could still treat it as liquid capital for a down payment on a house. Still, it could sit there for a couple months so it's something to look into. Especially if we decide not to buy until next summer.
posted by Smarson at 1:53 PM on March 26, 2008
Dec One - Good point, except the whole reason for dropping the $8000 into a Traditional IRA in the first place is so that we could still treat it as liquid capital for a down payment on a house. Still, it could sit there for a couple months so it's something to look into. Especially if we decide not to buy until next summer.
posted by Smarson at 1:53 PM on March 26, 2008
The IRS is most certainly concerned with the spirit of the law. The whole point of tax shelters is that they comply with the letter of the law but not the spirit- the IRS aggressively attacks tax shelters. From irs.gov: "When a transaction is treated as a sham, the form of the transaction is disregarded in determining the proper tax treatment of the parties to the transaction. A transaction that is entered into primarily to reduce taxes and that has no economic or commercial objective to support it is a sham and is without effect for federal income tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561 (1978); Rice's Toyota World Inc. v. Commissioner, 752 F.2d 89, 92 (4th Cir. 1985)." If the IRS threw up their hands every time someone got around taxes by following the letter but not the spirit of the law no one would pay any taxes! There are too many loopholes like this.
I'm not saying that you would get audited, or even if you did get audited that this would be disallowed. I don't know enough of the facts or the law. I just wanted to throw it out there as something to think about. Frankly, if I were you, and I had no reason to think I would ever get audited (don't run a business out of the home, don't engage in currency trading, have never been audited before- there are certain factors that make you more likely to get audited) then I would probably do it to.
posted by ohio at 2:04 PM on March 26, 2008
I'm not saying that you would get audited, or even if you did get audited that this would be disallowed. I don't know enough of the facts or the law. I just wanted to throw it out there as something to think about. Frankly, if I were you, and I had no reason to think I would ever get audited (don't run a business out of the home, don't engage in currency trading, have never been audited before- there are certain factors that make you more likely to get audited) then I would probably do it to.
posted by ohio at 2:04 PM on March 26, 2008
Another point: this usually applies only to businesses, so even less reason to worry about it. I don't even know for sure if the sham/economic substance or step transaction doctrine can by applied to individuals! I'm not trying to start a fight, I just wanted to point it out so you were aware that there were potential, if highly remote, legal problems. This makes some people very nervous, and other people aren't bothered at all. I don't know which one you are.
posted by ohio at 2:07 PM on March 26, 2008
posted by ohio at 2:07 PM on March 26, 2008
This thread is closed to new comments.
1. Probably legit. With Roth IRAs you have to keep the money in the IRA for five years to avoid penalties. Google isn't giving me anything that specifically says this doesn't apply to traditional IRAs. Maybe someone else can find something. Shifting income around like this is what rich people pay expensive accountants for (usually with more at stake).
2. Ask your IRA custodian. It's probably fine.
3. I don't know, I can't tell from their web site what their fees for IRAs are. There are plenty of no-fee IRA options. Just Google "no-fee IRA".
posted by Dec One at 12:03 PM on March 26, 2008