By Sarah Brenner
The real estate market is hot. It is a seller’s market in much of the country and buyers face challenges. They may need to move quickly or come up with cash fast to make a better offer. They may also need to show adequate resources to get financing. Realtors and mortgage brokers eager to close a deal may encourage buyers to tap any available resource to secure a dream property.
For many Americans, their IRA is their largest asset. It is not surprising, then, that they turn to their IRA as a quick source of cash in a real estate crunch. Why not borrow from the IRA instead of securing a bridge loan? Why not use the IRA as an immediate cash resource for a down payment and pay the IRA back later?
Advisers should urge caution. There are IRA rules that make things far more complicated than you might expect.
Some employer plans, like a 401(k), include provisions where participants can take loans. But IRAs are different. There are no loan provisions for IRAs. In fact, taking an actual loan from an IRA would be considered a prohibited transaction and could result in the IRS considering the entire IRA liquidated and the retirement savings lost.
Since IRAs do not have loan provisions like qualified plans, the only way to “borrow” IRA funds on a short-term basis is to take a distribution, use the funds as needed, and then replace them in the IRA by doing a 60-day rollover.
There is nothing in the rules that prohibits an individual from taking a distribution whenever they want from their IRA and for whatever purpose they choose. There is also no rule that limits what can be done with the money while it is out of the IRA during the 60-day period before the rollover. So yes, technically, it is possible to take money from an IRA as a “short-term loan” for a real estate purchase using the 60-day rollover rule.
Encouraged by real estate professionals with potentially little knowledge of the IRA rules, clients may be eager to jump at this opportunity.
Is this a good idea? Here is where advisers can add real value by cautioning clients. A 60-day rollover can be risky. There are a multitude of rules that must be followed, and a plethora of potential pitfalls that could result in significant taxes and penalties.
A major concern with using an IRA for a short-term real estate loan is the rollover deadline. One does not have unlimited time to complete a rollover. There is a hard-and-fast 60-day window to finalize the transaction. The 60-day clock starts ticking when the distribution is received by the client.
It is not unusual in real estate transactions for things to veer off schedule. Timelines get extended, and properties do not sell as quickly as expected. This is a problem when it comes to the rollover deadline.
What if a sale falls through and the client does not have the replacement cash to complete the rollover by the deadline? The consequences are serious. They would be facing a taxable IRA distribution and potential early distribution penalty.
Do not expect any sympathy from the IRS. In several private letter rulings, the IRS has refused to grant relief to taxpayers who used 60-day rollovers to take short-term loans from their IRAs to purchase real estate but failed to complete a rollover by the deadline. A failed short-term loan to buy a new home is nowhere to be found on the list of reasons for which the IRS will forgive a late rollover through the self-certification process.
Another concern is the once-a-year rollover rule applicable to IRA-to-IRA and Roth-to-Roth IRA rollovers. For purposes of this rule, traditional and Roth IRAs are combined. This means that a distribution and subsequent rollover between a client’s Roth IRAs will prevent another 60-day rollover within a one-year period between that client’s traditional IRAs or between other Roth IRAs.
This rule prevents clients from doing a rollover from an IRA distribution made within 12 months of a prior distribution that was rolled over. The 12-month period is a full 12 months. For example, Sally received an IRA distribution in December and did a 60-day rollover to another IRA. She is not eligible to do another 60-day rollover from any IRA or Roth IRA distribution she receives before the following December. The 12 months begin with the date the first distribution is received by Sally.
If a client has already rolled over an IRA distribution taken in the past 12 months, she cannot use her IRA to take a short-term loan to purchase real estate.
Instead, any IRA or Roth IRA distribution taken within one year of the previous distribution would be subject to taxation and the 10% early distribution penalty if under age 59½. This is a mistake that cannot be fixed. There are no remedies available under the tax rules or from the IRS. Additionally, if a client does attempt to make a rollover deposit, the funds would then be treated as an excess contribution and may be subject to an annual 6% penalty unless properly corrected.
Using your IRA for a short-term loan to purchase real estate by doing a 60-day rollover is permitted but should be avoided if possible. The risks are high and the cost of things not going as planned could result in a tax bill and the loss of retirement savings — with no likely relief from the IRS.
Advisers should warn clients of the potential pitfalls. If a client is still interested in proceeding with such a plan, an adviser should carefully assess the situation to be sure that none of the strict rollover rules are violated. What was intended to be a short-term loan to acquire a dream home could easily result in the loss of a client’s hard-earned retirement savings. No adviser wants that nightmare.
Sarah Brenner, JD, is director of retirement education for Ed Slott and Co. She has worked for almost 20 years helping clients solve complex technical IRA questions. She is a contributing writer and editor for Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisers nationwide, and writes for several areas of the company’s website, IRAHelp.com.
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