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Tax Kills Family Loans for Homebuyers. For most people, the highest
financial barrier to owning a home is the down payment. It can be a lot
easier to come up with the cash, however, with an infusion of family funds.
Why not borrow some money from your Individual Retirement Account (IRA) to
help the kids buy a home? Unfortunately, it's not as simple as it sounds.
It's impossible to borrow funds from your IRA for a home loan without paying
taxes on whatever you withdraw. That kills the idea for most people. Do the
math. On a $10,000 withdrawal, you pay $2,800 if you're in a 28 percent tax
bracket. After taxes, that leaves only $7,200 for your son's, daughter's or
grandchild's down payment or closing costs.
Bill Axes Tax. That is why Congressman John LeFalce (D-NY) has introduced
H.R. 1333, the "First-time Homebuyer Affordability Act." Under the proposed
bill, anyone can make a first-time homebuyer loan to a child, grandchild,
spouse or grandparent using up to $10,000 in IRA funds--without paying income
taxes on the withdrawal. A first-time homebuyer is defined as someone who
hasn't owned a principal residence for 24 months.
Unfair Tax. The tax penalty is another example of a good idea gone bad. Out
of concerns that wheeler-dealers might use their tax-deferred IRA savings for
risky investment schemes, Congress some time ago placed two restrictions on
IRA withdrawals: 1 - You pay a 10 percent penalty for withdrawing funds
before age 59 1/2, and 2 - You pay income taxes at your regular rate on
whatever you withdraw. It seems reasonable until you compare IRAs with
employer-sponsored 401k retirement plans or the government's own employee
retirement plan--both allow penalty-free, early withdrawals up to a certain
specified amount. IRA accounts, on the other hand, allow no such withdrawals
without a tax penalty.
Congress Waking Up. Fortunately, Congress is gradually waking up to the
problem. In 1997 it addressed the 10 percent penalty by passing legislation
that allows IRA holders to remove funds up to $10,000 for home buying
purposes. But that only solved half the problem. H.R. 1333 would solve the
rest of the problem by removing income taxes, too, at least for home loans to
family members. What's the catch? No outright gifts are allowed--you must
loan the money and charge interest. Nonetheless, the proposed loan terms are
quite favorable--your family member can take up to 15 years to pay it off on
an interest-only basis. Remaining principal would be due either when the
house is sold or at the end of the loan term.
H.R. 1333 has been referred to the House Ways and Means Committee where it
will need to be passed before the full House of Representatives can approve
it. The Senate has yet to consider a similar bill.
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