IRA transfer in divorce

[DaveO]

Client just called me and said her divorce was in the final stages. Her mediator was unavailable so she called me with a question. She received a portion of her husband’s IRA which was directly transferred into a new account in her name. She is looking to purchase a house. Her mediator told her that she had a specific period of time in which she could withdraw money from the IRA free of penalty or tax to use as a down payment on the new house. She called because she couldn’t remember if it was 60 or 90 days.

I explained the first time home buyer rules but since she owned a home with her husband I can’t see how she would qualify. Also explained the 60 days was a rollover rule. Pub’s 504 and 590 offered no other answer. Anyone ever heard anything else or is this just another case of a non-tax pro giving tax advice?

[Jesse]

If properly done QDRO she could have taken the money, or a portion of, penalty "free" and rolled the remainder into an IRA of her own within the 60 day period. Now that it is rolled over into an account of her own I think she is out of luck, no penalty relief. And I think you need no have no ownership in a home for a period of 5 years before the "first time" home buyer applies.

This just off the top of my head so I'm sure someone will jump in and correct me if I'm wrong, or maybe confirm if I'm correct.

[Roland Slugg]

2 years, not 5

Per Code §72(t)(8)(D)(i)(I) ....

FIRST-TIME HOMEBUYER- The term "first-time homebuyer" means any individual if-- (I) such individual (and if married, such individual's spouse) had no present ownership interest in a principal residence during the 2-year period ending on the date of acquisition of the principal residence to which this paragraph applies.

[abby]

2 separate issues

I think there are two issues that appear to be mingling in the advisor's mind - taking a distribution from a QDRO and a downpayment on a house exclusion.

Still, in either case, the distribution can be penalty free if it is qualified, but in neither case is it tax free. (See TTB 13-23)

A distribution from an employer plan can qualify for cash out AND a rollover, but an IRA normally wouldn't be a qualified employer plan - so only a rollover is possible. I had a client misinformed on this by an attorney a few years back and it was devastating enough for all concerned that my memory of the rules are quite vivid and I believe I'm on solid ground with that.

I'm on shakier ground here, but I believe even a SEP or SIMPLE wouldn't be considered a qualified employer plan for a QDRO because the employee 'owns' the IRA outright after the deposits are made. Happy to have this confirmed or corrected.

The housing exclusion - I was wondering, would a spouse be excluded by the 2 out of 5 if she had no ownership interest in the house? In a non-community property state it seems that might be possible.

[Jesse]

She received a portion of her husband’s IRA which was directly transferred into a new account in her name.

The distribution can be penalty free if it is a qualified QDRO, but it must be taken directly from the original distribution. Once transferred into the new account it now cannot be taken out penalty free, unless another exception applies such as first time home buyer, tuition, medical in excess of 7 1/2%, etc....

[Jesse]

The housing exclusion - I was wondering, would a spouse be excluded by the 2 out of 5 if she had no ownership interest in the house? In a non-community property state it seems that might be possible.

Do you mean if the spouse's name was not on the property deed to begin with and after marriage the property deed was not changed to add the spouse therefore spouse never really had ownership interest?

[Lion]

Selling vs. buying

The 2 out of 5 is part of the selling requirements for good tax consequences. To be a first time buyer, you can't have owned a home during the last two years before buying the new home you're hoping to qualify for first time home buyer status. The regs say something about ownership by marriage, so you'll need to do further research if your client lived in a home within the last two years that was owned by her spouse during the time they lived there together as husband and wife. It might mark her as a home "owner" for the purpose you're looking at.

[abby]

right

I wasn't sure if there was anything stating that the 2 out of 5 rules would apply to spouse with no legal ownership before or after the divorce in a non community property state.

[DaveO]

Thanks for the input

She is a co-owner of the house so I can't see how she could take a first time home buyer distribution.

QDRO rules don't apply to IRA's only to 401K, 403B, etc plans.

They are trying to sell the jointly owned home but it's a tough market right know. She might be able to take a distribution for a down payment then return the money within 60 days if the jointly owned house sells. The timing would be very close on that one.

I have to guess either she got bad advice or she heard something different than what her advisor was telling her.

[Jesse]

I stand corrected.....again!

QDRO rules don't apply to IRA's only to 401K, 403B, etc plans.

I blanked that out, you are correct, you can transfer the IRA w/ QDRO so neither of the spouses is taxed or penalized, however, it must transfer into a qualified retirement plan or 10% penalty is incurred as well as the income tax.

With the 401k QDRO you can keep all or a portion w/out the 10% penalty imposed, but you must pay the income tax.

I had a client a few years ago who wanted to keep part of the 401k transferred by QDRO and roll the remainder into an IRA. We set it up with a financial planner, however the fp did not listen and he had the entire proceeds direct transfer into the IRA and then he cut the check from the IRA for the amount my client wanted to keep. It was too late, once it went into the IRA the option was not there to keep a portion penalty free.

Also ran into this with a SIMPLE IRA, lawyer said you could transfer w/ QDRO and not pay penalty. Tried to explain yes you can transfer w/QDRO, however, you must transfer into a Qualified retirement plan to avoid 10% penalty, actually if I recall correctly it was 25% because was in first two years of the plan that the w/drawal took place. She never did come back to me for the actual tax prep because she knew I was incorrect and her lawyer was, of course, correct.