Can I repair my new home with IRA funds as 1st time home buyer without penalty?

[mikerowe14]

I will be purchasing a home in January\February and using some of my traditional IRA funds as a down payment.  I understand that I qualify under the 1st time home buyer clause to avoid the 10% early distribution penalty.  Can I also use funds to replace the very old furnace and lay carpet in a room that just has sub-flooring right now?  The wording in the tax code is very vague.  It says it must be used for "qualifying acquisition costs", which are defined as 

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

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

The furnace was noted as being faulty in the home inspection and the room requiring carpet must be done before closing under an FHA loan. 

[Opus 17]

No. The improvements add to the value of the house and are not eligible for the penalty exclusion.  However, specific dollars are not tracked -- it doesn't matter if the withdrawal is used for the improvements and then you use other cash for the closing as long as the money you provide to close (deposit, down payment, other closing costs) are equal or more than the amount you withdraw from the IRA.  And there is a $10,000 max on the penalty exclusion.

[mikerowe14]

Thank you.  Your reply sparked an additional question:  If the seller is bringing money ($5K) to the closing costs, if total closing cost at close is $10,000, would I be able to use money for the fixes under the total cost to close?

[Opus 17]

I think so.  The $5000 is treated as a price reduction for tax purposes, so if your closing costs (downpayment plus escrow funding plus other fees) are more than $10,000, you can use the penalty-free distribution.  Or another way of looking at it would be, you use $10,000 of the IRA to close, and use the $5000 from the seller for the repairs.

@Critter I saw you voted this up, do you agree on the followup?

[Critter1]

Yes, if the IRS audits the return the amount paid on the closing costs & down payment must be the same as the IRA distribution so you can legally take the exemption from the penalty. This is to keep folks from taking a distribution that would otherwise not qualify. If the deal is structured correctly, there is no issue with a buyer walking away from the closing with cash in their pocket which can be used for those improvements. Even if you have to make the repairs to get the loan find someway to do this without tapping into the IRA  or  if you need to tap the IRA then you have only 60 days to put it back however this "self loan" can only be done once in a 365 day period per person (new rule).

[SweetieJean]

Alos keep in mind that the $10,000 limit that is not subject to the 10% penalty refers to the distribution itself (not the penalty amount).