IRA money for first time home purchase

[mactoolsix]

Have client (about 45 yrs old) that took a $37,000 distribution for a down payment on a new home - $10,000 should avoid the penalty.

However, a twist:

Her mother originally owned the home. She died about 10 years ago, and the home title was passed to Mom's trust. Two beneficiaries - our client and her sister. Client paid mortgage & taxes for 10 years in exchange for living in the home. In Dec. 2012 she purchased the home from the trust. We don't do the trust return, but I doubt there was much gain to distribute.

I'm struggling with two possible problems:
1.) Is this a related party transaction, and if so does that violate the IRA penalty exception rule.

2.) Since she is a beneficiary of the trust, did she really buy a new home?

Mike

[Koss]

IRA Penalty Exception

Transactions between a trust and a beneficiary of the trust usually fall into the definition of a related-party transaction.

But I don't think that's relevant here.

Publication 590 describes the exception, and says nothing about related-party restrictions. It does give a very specific definition of a first time homebuyer.

And it's not the definition that was applicable to the First Time Homebuyer Credit.

The First Time Homebuyer Credit definitely had restrictions on related parties. Maybe that's what you're thinking of...

BMK

[mactoolsix]

From Pub 590

From the Pub Koss recommended:

First-time homebuyer.
Generally, you are a first-time
homebuyer if you had no present interest in a main home
during the 2-year period ending on the date of acquisition
of the home which the distribution is being used to buy,
build, or rebuild.

So, would the beneficiary have a "present interest"?

Mike

[Koss]

Present Interest

Mactoolsix wrote:

So, would the beneficiary have a "present interest"?

Very good question. I overlooked this issue.

You won't like my answer.

It depends on the terms of the trust.

If she had to buy the house from the trust, then she probably did not have a present interest. She may have had a remote or contingent interest. But you won't know for sure unless you read the trust instrument.

BMK

[mactoolsix]

Koss,
Thanks for the direction - I googled present interest and found a legal explanation that stated if there is a present right to the use of the property, that would be present interest. Like you recommended, I think we'll have to take a look at the trust document on this one.

Mike

[BOB W]

Sounds like she was a "Renter" since she paid all expense instead rent. She was not a benificiary since she had to buy the home.

[Lion]

Did she have a present interest in half (or some other percentage) of the home and buy only her sister's interest?

[Roberts]

From the OP :"Two beneficiaries - our client and her sister."

IMO, she in effect already had claim on 50% of the property and just bought out the other half.

[Koss]

Details

Lion wrote:

Did she have a present interest in half (or some other percentage) of the home and buy only her sister's interest?

Roberts wrote:

IMO, she in effect already had claim on 50% of the property and just bought out the other half.

These are interesting observations, but I still think you have to read the trust instrument.

The original post says that she paid the mortgage and taxes in exchange for living in the home. And, as noted in other comments, there is a second beneficiary--her sister. Presumably, her sister was not living in the home.

And the original post says that the mother died ten years ago, and the house has been in the trust ever since.

The client may not have had any rights to live in the home, especially if she had to pay in order to do so. She may have held a beneficial interest, as a beneficiary of the trust, but that's not a present interest. Her right to occupy and use the home may have arisen out of an agreement with her sister, or a decision made at the discretion of the trustee.

Why did the house remain in the trust for ten years after the death of the mother? There's nothing wrong with this, especially if that's what's written in the trust. But it suggests that neither sister had a present interest.

What if the two sisters couldn't agree on who was going to live in the house?

Did the trustee have the authority to say, "Well, both of you can go fly a kite. The house is going up for sale. And if I can't sell it, I'm going to rent it at fair market value. And if both of you want to rent it, I'll turn this over to a real estate agent, and it will be rented to the applicant who has the best credit profile and rental history."

As beneficiaries, each sister may well have been entitled to half the proceeds from the sale, or half the net rental income. But that's a beneficial interest--not a present interest in the ownership of the home.

You gotta read the trust instrument.

BMK

[Koss]

Further thoughts...

As I noted in my earlier remarks, I think the tax pro should review the trust instrument.

This is kind of a gray area, where something other than tax law is involved. We're dealing with real property law, and trust law, which varies from state to state, and--as noted--hinges heavily on the terms of the trust.

If there was a lot of money involved, or a large tax liability in question, then I might suggest talking to an attorney.

But what's at stake here? The ten percent penalty on a $10,000 early distribution from an IRA. We're talking about $1,000 in tax liability.

If the language of the trust suggests that the client did not have an unfettered right to the house, I would just take the ball and run with it. Claim the exception to the penalty on Form 5329, and move on.

It's a reasonable position. If the IRS challenges it, they'll probably waive the accuracy-related penalty.

And it's not likely to come up on the IRS radar screen. In the records of the county recorder, the client did not hold title to the house during the last two years. On the surface, there is no evidence to suggest that she does not meet the definition of a first-time homebuyer. And she has a closing statement and a deed to show that she bought a house. In principle, this might shift the burden to the IRS to show that she did own a primary residence during the applicable window of time. That's not how tax law usually goes--normally, the taxpayer has the burden of proof. But this case is a little different...

BMK

[mactoolsix]

A quick uodate

Yes, client lived in the house, her sister lives elsewhere.

Client was attending medical school and could not afford the purchase.

She called today for a progress report and I explained the "present interest" and asked for a copy of the trust. She is on good terms with her attorney and is going to try to get a legal opinion.

The tax? $1,000 Federal savings and $250 State savings (CA).

Thanks for all the interest,
I'll keep you posted if the attorney responds,

Mike