Early withdrawal of Roth IRA for downpayment

[Todiep83]

I will be making an early withdrawal of $10,000 from my Roth IRA, which was opened in 2008 for a newly built construction home. However, the home won’t be built until Feb 2021. Along the way, I will be adding upgrades to the home where I will have to put a deposit. The deposit will go into the escrow account and count towards the down payment. I know there’s a rule of spending the withdrawal amount within 120 days. All the upgrades/deposits will be within 120 days. Does this fall in line with purchasing a new home? Thanks

[macuser_22 · Accepted solution]

If you are over 59 1/2 then it is irreverent.

Here are the rules:

https://www.irs.gov/pub/irs-pdf/p926.pdf

First home.

Even if you are under age 59½, you don't have to pay the 10% additional tax on up to $10,000 of distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.

1. It must be used to pay qualified acquisition costs (defined next) before the close of the 120th day after the day you received it.

2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined below) who is any of the following.

   1. Yourself.

   2. Your spouse.

   3. Your or your spouse's child.

   4. Your or your spouse's grandchild.

   5. Your or your spouse's parent or other ancestor.

3. When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions can't be more than $10,000.

If both you and your spouse are first-time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.

Qualified acquisition costs.

Qualified acquisition costs include the following items.

• Costs of buying, building, or rebuilding a home.

• Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer.

Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

Date of acquisition.

The date of acquisition is the date that:

• You enter into a binding contract to buy the main home for which the distribution is being used, or

• The building or rebuilding of the main home for which the distribution is being used begins.

If you received a distribution to buy, build, or rebuild a first home and the purchase or construction was canceled or delayed, you could generally contribute the amount of the distribution to an IRA within 120 days of the distribution and not pay income tax or the 10% additional tax on early distributions. This contribution is treated as a rollover contribution to the IRA.

[Opus 17]

For a Roth IRA, you may withdraw principal contributions tax-free at any time.  You only have to worry about tax and penalties if you are dipping into the income (growth).

If you are dipping into the growth, then that part of the distribution will be subject to income tax and a 10% penalty if you are under age 59-1/2.  You can be exempt from the 10% penalty using the first time home buyer rule.  In the case of a home under construction, the 120 days counts backwards from when you start living in the home (it is complete and you have a C/O and move in). 

[tam3rd]

How do you document that your withdrawal is principal and not earnings? We mistakenly made an early withdrawal 22 days before actual 59 1/2 and can't understand how not to pay the full 10% and penalty?

[macuser_22]

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@tam3rd wrote:

How do you document that your withdrawal is principal and not earnings? We mistakenly made an early withdrawal 22 days before actual 59 1/2 and can't understand how not to pay the full 10% and penalty?

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You must keep track of your own contributions using your records.

You can always withdraw your own Roth contributions tax and penalty free.

Enter a 1099-R here:

Federal Taxes,
Wages & Income
I’ll choose what I work on (if that screen comes up),
Retirement Plans & Social Security,
IRA, 401(k), Pension Plan Withdrawals (1099-R).

OR Use the "Tools" menu (if online version under My Account) and then "Search Topics" for "1099-R" which will take you to the same place.

Be sure to choose which spouse the 1099-R is for if this is a joint tax return.
Be sure to pick the correct 1099-R type: Standard 1099-R, CSA-1099-R, CSF-1099-R, RRB-1099-R.

[NOTE: When you get to the "Your 1099-R Entries" screen where you can add another 1099-R, use "continue" to keep going as there are additional interview questions after that screen in most cases. You can always return as shown above.]

One of the followup questions will ask for your prior year** contributions not previously withdrawn. Those contributions that still remain in the Roth will not be taxed or subject to a early withdrawal penalty. That will add a 8606 form to your tax return with the Roth contribution and tax calculation in part III.

Note: **Prior year - any current year Roth contributions should be entered into the IRA contributions section. They will not show up in the prior years contributions but will be accounted for on the 8606 form that calculates the taxable amount.

[Opus 17]

@tam3rd 

You must keep track yourself, and enter the information on your tax return.  If you have not been keeping track, you can probably get the information from the plan custodian.

The IRS should also be keeping track, because the plan custodian send them a copy of form 5498 each year showing your contributions. And the IRS will assess extra tax to you if they calculate that you have withdrawn earnings, based on their records.  But the fun thing about the IRS is that if you pay tax because you think you have withdrawn earnings, but the IRS thinks you only withdrew contributions, they won’t contact you to give you a refund of the excess tax you mistakenly paid.

[tam3rd]

Thanks for all the great helpful information! One last thing, my wife converted a substantial amount from traditional IRA to her Roth early in 2021. The question in TurboTax asking for conversion information asks only for prior to 2021? Can I insert that in the 8606 worksheet?

[Opus 17]

@tam3rd 

when asked for prior conversion amounts, only enter the prior conversions. The current 2021 conversion will be captured using the 1099R that you must enter to pay the tax on the conversion.