Can $2,000 of a $12,000 early distribution from a Roth IRA be considered a tax-free, penalty-free early distribution of contributions and the other $10,000 be considered a tax-free, penalty-free first-time homebuyer early distribution?

[jwkinrva]

@macuser_22  @DanaB27 

On June 7, 2019 at 4:02 PM, macuser_22, a Level 15 Champ, stated, “You can always withdraw your own previous contributions from a Roth both tax and penalty free. Only the earnings are subject to the penalty, so you only need to exclude the earnings from the penalty. For example, if you have previously contributed $8,000 to the Roth and now that has grown to $15,000, you can withdraw the entire $15,000 penalty free. You would enter $8,000 as previous contributions and $7,000 as a [first-time] homebuyer’s exclusion and still have $3,000 left in the lifetime $10,000 limit.”

Questions

1. Is macuser_22’s example above still valid?
2. If macuser_22’s example above is still valid, does my Proposed Tax Strategy make sense?

Background: In 2020 at age 56, I took a $12,000 early distribution from a Roth IRA funded between 1995 and 2000 with total contributions equal to or greater than $2,000. (I am having difficulty documenting my contributions.)

Proposed Tax Strategy

1. The first portion, i.e., $2,000, was a tax-free, penalty-free early distribution of contributions, and
2. The second portion, i.e., $10,000, was a tax-free, penalty-free early distribution used within 120 days of the distribution to purchase a home as a qualified first-time homebuyer.

[ColeenD3]

Yes.

You can always withdraw contributions (but not earnings) that you made to your Roth IRA tax and penalty free at any time. Additionally, the Ordering rules for withdrawals from a Roth IRA are: first from regular contributions, then from Conversion and rollover contributions, on a first-in, first-out basis and finally from Earnings on contributions.

Please note: A qualified distribution from a Roth IRA is tax-free and penalty-free, provided that the five-year aging requirement has been satisfied and one of the following conditions is met:

• Over age 59½
• Death or disability
• Qualified first-time home purchase

A non-qualified distribution is subject to taxation of earnings and a 10% additional tax unless an exception applies. For Roth IRAs, you can always remove post-tax penalty contributions (also known as "basis") from your Roth IRA without penalty.

When you are entering this information into TurboTax, your Form 1099-R, box 7 codes J, Q and T identifies a Roth IRA distribution and determines the tax treatment. If you have a J or a T, the distribution is considered taxable unless there is an exception. TurboTax will guide you on all the exceptions.

[QRFMTOA]

@ColeenD3 

Thank you so very much for taking the time to share your knowledge with me!

JWKinCVA

[jwkinrva]

@ColeenD3 

Thank you so very much for taking the time to share your knowledge with me!

JWKinRVA

[QRFMTOA]

Obviously, I wanted to make sure the IRS was not going to object to categorizing the first $2,000 as the early distribution of contributions instead of the last $2,000!

Thanks, again.

JWK

[fanfare]

@QRFMTOA 

The key is 5329 Line 2 "Early distributions included in income".
Your withdrawn contributions are not included in income.

According to the instructions for 5329,

it then states
The additional tax on early distributions
doesn’t apply to the distributions
described next. Enter on line 2 the
amount that you can exclude

09 IRA distributions made for the
purchase of a first home, up to
$10,000.

Note:
There is a special case if you did conversions of an IRA into a Roth.

that's a whole other can of worms we won't go into.

[Opus 17]

You have to follow the ordering rules for Roth withdrawals. Contributions are always withdrawn first.

You say your contributions were "equal or greater than $2000" and you are having a hard time documenting this.  Suppose your contributions were $2500.  Your $12,000 withdrawal MUST be $2500 of contributions and $9500 of earnings.  You can't say "it's $2000 of contribution and I'll leave the other $500 of contributions for later."

Put another way, if you report that your 2020 withdrawal was $2000 of contributions and $10,000 of earnings, then if you have any money left in the account, the IRS will consider it all earnings when you withdraw it later.  You will have shown by your 2020 tax return that all the original contributions were withdrawn.  

Then, if the earnings withdrawal is not qualified, you will owe regular income tax plus a 10% penalty.  Using the money for a qualifying first time home purchase will exempt you from the 10% penalty but not the regular income tax.  To be "qualified," you must be over age 59-1/2 and the Roth account must have been open at least 5 years. 

From the IRS:

There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. For these purposes, disregard the withdrawal of excess contributions and the earnings on them (discussed under What if You Contribute Too Much? in chapter 2 of Pub. 590-A). Order the distributions as follows.

1. Regular contributions.

2. Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion and rollover contributions into account as follows.

   1. Taxable portion (the amount required to be included in gross income because of the conversion or rollover) first.

   2. Nontaxable portion.

3. Earnings on contributions.

Disregard rollover contributions from other Roth IRAs for this purpose.