I'd like to take funds out of a traditional IRA for the purchase of a first home. My financial service provider confirmed that I am eligible to withdraw these funds for this purpose, but the tax document I receive from them will indicate it is an early distribution. They advise I work with a tax consultant to have the 10% early distribution penalty waived. How do I go about doing this? What information would the tax consultant or IRS need to receive in order to ensure the penalty is waived?
Traditional IRA withdrawals before age 59 ½ are permitted without penalty if used for a first-time home purchase. Over one’s lifetime, you can withdraw up to $10,000 penalty free from your IRA to help buy, build, or pay financing and closing costs for a “first home.” The withdrawal will be taxable, however, so plan to report it as income, but you can get any early withdrawal penalty waived.
There are some timing and reporting complexities that must be coordinated. First, you must sign the agreement of sale/purchase within 120 days of your IRA distribution. Next February, the IRA custodian will issue a Form 1099-R to report the withdrawal. The form has a distribution code that the custodian should set to “2,” which indicates that an exception applies. We suggest you provide the withdrawal instructions to your custodian in writing, and include the fact that you intend to use the withdrawal for a first-time home purchase and you want to make sure they use the proper code when issuing the 1099 later. If need be, you may also need to contact your IRA custodian for a corrected 1099-R form if not properly coded.
When you file your tax return, you’ll need a Form 5329 that indicates your early distribution is exempt from penalty. The first-home exception number to report on the form is “09.” You should also attach a dated copy of the agreement of sale and HUD-1 documents (sometimes known as the “Settlement Sheet”) signed at closing to your tax return to prove you qualify for the penalty exemption.
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Answered by: Thomas N. Alvaré, CPA, is managing principal with JFS Wealth Advisors in Doylestown, Pa.