First-time Home Buyers: Do You Qualify for an Exemption?

As a general rule, distributions from IRAs and qualified retirement plans are subject to a 10% early distribution penalty if the taxpayer does not meet one of the exceptions described under IRC section 72(t). IRC section 72(t)(2)(F) states that distributions from certain plans for first home purchases are an exception to the 10% penalty.

The taxpayer argued that a distribution received from her 401(k) retirement plan should not be subject to the 10% penalty because she used the distribution to help finance the purchase of her first home. The IRS stated the exception only applies to a distribution from an individual retirement account or individual retirement annuity. The exception does not apply to distributions from a 401(k) retirement plan. The court noted the title to IRC section 72(t)(2)(F): "Distributions from certain plans for first home purchases." The court stated that although statutory titles and section headings do not define a statute's meaning and are not generally relied on at the expense of the statutory text itself, such titles and headings are tools available for the resolution of a doubt about the meaning of a statute. The use of the adjective "certain" in the title of IRC section 72(t)(2)(F) suggests that the subparagraph excepts from the 10% additional tax distributions from some, but not all, qualified retirement plans. But neither the title of IRC section 72(t)(2)(F) nor the text of the section itself tells us which individual retirement plans come within the scope of the exception and which do not.

The court stated it is clear that the exception applies only to distributions from individual retirement plans. The term "individual retirement plan" is not defined in IRC section 72. However, IRC section 7701(a)(37) provides a definition that is generally applicable throughout the Internal Revenue Code.

That code section provides that the term "individual retirement plan" means:

  • An individual retirement account described in IRC section 408(a), and

  • An individual retirement annuity described in IRC section 408(b).

The definitions describing those types of accounts apply only to individual retirement accounts and annuities (IRAs) and not to other types of retirement plans such as 401(k) plans. IRC section 72(t)(1) serves to impose the 10% additional tax on "qualified retirement plans" as defined in IRC section 4974(c), and such plans include both 401(k) retirement plans and IRAs. In stark contrast, the first home purchaser exception in IRC section 72(t) (2)(F) applies only to an "individual retirement plan," a term which includes only IRAs. A 401(k) retirement plan is not an IRA. Thus, the exception to the 10% penalty for the purchase of a first time home does not apply to distributions from 401(k) retirement plans.

Planning Tip: First roll the 401(k) distribution into an IRA. Then take a distribution from the IRA to purchase the first time home. IRC section 72(t)(2)(F) does not impose a minimum holding period inside the IRA in order to qualify for the exception.

For more tax tips such as these, follow our blog here!

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