IRA Still Off-Limits for Home Down Payments
Q: I have been getting conflicting information on using my individual retirement account as a down payment for a home purchase. I remember reading that the usual 10% early withdrawal penalty would be waived for first-time home buyers. But now I have been told this is incorrect. What is the truth? --B.M.
A: The truth is that there are as yet no provisions to dismiss the 10% early withdrawal penalty for IRA disbursements used to purchase a first home. Congress has been talking about enacting such a provision for years, but so far there’s nothing on the books.
Perhaps the exemption to which you are referring is the one applying to 401(k) savings programs, which is not as sweeping or generous as you want. The Internal Revenue Service allows taxpayers to withdraw funds from their 401(k) tax-deferred savings plans for certain “hardships”--a catch-all category that includes medical expenses, the purchase of a principal residence, payment of college tuition for spouses or children and payment of a household rent or mortgage where eviction or foreclosure is threatened. Your company’s plan may accept additional hardship claims, such as funeral expenses, legal bills and loss of family income because of disability or a spouse’s layoff.
However, even if you have an accepted hardship case, taxpayers under age 59 1/2 who withdraw funds from their 401(k) plans are, with limited exceptions, automatically hit with a 10% federal penalty plus any applicable state penalty. (In California, the penalty rate is 2.5%.)
Buying a new home, whether or not it’s your first-ever purchase, is not one of the penalty exceptions. So off the top, you would be forfeiting at least 12.5% of your savings to the government. In addition to the penalties, you would be required to pay state and federal income taxes on the amount withdrawn. Assuming you are in the highest state and federal tax brackets, a $20,000 withdrawal from your 401(k) plan would net you about $10,700 toward your down payment.
Perhaps your best bet is to consider taking out a loan against your 401(k) account. Some companies allow their employees to borrow against their account totals, a strategy that avoids both the penalties and tax implications of a withdrawal.
Remarriage Affects Social Security Benefit
Q: My husband died three years ago at age 44. I am now age 53 and am remarrying. May I still draw on my deceased spouse’s Social Security? --C.A. A: No. Widows or widowers under age 60--the limit drops to age 50 when the surviving spouse is disabled--automatically forfeit their spousal Social Security benefits upon remarrying. However, if there are children of the deceased wage earner under age 18, their benefits will continue regardless of whether their surviving parent remarries.
Computing Taxable Gain on Home Sale
Q: My lawyer and accountant are giving me conflicting advice on how to compute the taxable gain from my home sale. Can you please resolve the matter? Our original home was purchased for $80,000 years ago, and we recently got $550,000 for it after expenses. We are eligible to use the $125,000 one-time profit exclusion available to homeowners over age 55. Our replacement home cost $300,000. Do we have a taxable gain, and if so, how much is it? --O.S.
A: This oft-asked question stems from continuing confusion over whether taxpayers are able to deduct both the original home’s basis (in your case, $80,000) as well as the replacement home’s cost ($300,000 in your case) from the sales price (in your case, $500,000). You may not. This is true whether the taxpayer is invoking the $125,000 senior citizen exemption or not.
This is how you should compute your taxable gain: Start with your $550,000 home sale gain and deduct the $300,000 value of your replacement home. From that remainder of $250,000, deduct your $125,000 exemption. Your taxable gain is $125,000. The basis of your new home is the $80,000 cost of your original residence.
If you were not eligible for the senior citizen exemption, your taxable gain would be $250,000.
Tax-Free Gifts--Above and Beyond
Q: I am confused about the $10,000 tax-free gifts one person may give another each year. Are these deducted from an individual’s $600,000 lifetime gift allowance?
Also, you mentioned a while ago a $1-million lifetime exemption for property transfers between parents and their children in California. What is this all about? --R.E.D.
A: The $10,000 a taxpayer can give anyone else every year is above and beyond the $600,000 lifetime exemption. There is no need for a separate accounting of these gifts.
The $1-million lifetime exemption for real estate transfers applies only to real estate tax consequences--not estate or gift tax issues. California law allows parents to give their children (or vice versa) up to $1 million (in assessed value) of real estate without triggering a reappraisal by the county for property tax purposes. This is entirely separate from other tax consequences of such a transfer.
