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IRAs and the first-time home buyer

Chris Farrell Aug 26, 2011

Question: Other than the modest amount that can be taken out of a Roth IRA for a first home, and the tax credit, are there other tax-advantaged savings vehicles or tax advantages available to first time home buyers? Dave, Pittsburgh, PA

Answer: Not really. The first-time homebuyer tax credit has expired. The multiple tax advantages of ownership are enjoyed by all homeowners. The tax breaks include everything from the mortgage interest deduction to the generous exclusion on capital gains.

However, let’s use your question to look at the IRA option for the first-time homebuyer.

Contributions to a traditional IRA are paid with pretax money. You can withdraw up to $10,000 from your IRA before age 59 ½ without paying the 10% penalty if the money goes toward first-time home buying expenses. (The first-time homebuyer is defined as someone who hasn’t owned for two years. Go figure!). You will pay ordinary income taxes on the money withdrawn from the account, however.

The Roth-IRA rules are complicated and potentially more generous. Since a Roth is funded with after-tax dollars you can always take out the amount of your contributions without penalty and taxes. On top of that contribution sum, you can tap up to $10,000 of earnings (or $10,000 from a conversion into a Roth) without penalty as a first-time homebuyer. You will owe taxes on that portion of the withdrawal.

Now, my rule of thumb is don’t dip into retirement savings to own a home. For one thing, it’s a signal that your finances might not be sufficiently flush to buy, own, and maintain a home. For another, the withdrawal erodes one of the main advantages of establishing a retirement savings account: The compounding effect of time and money.

What other options are there. Federal, state and local governments offer various programs to help first-time homebuyers. You can learn more about what’s available at the HUD website. The list of state and local home-buying resources in Pennsylvania is here.

These programs are typically geared toward low-income households. In return for favorable home-buying terms the programs usually come with limits on any gain. Most people with good credit that qualify for a conventional mortgage will do better on their own–especially with today’s extremely low mortgage rates.

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