Mortgage Lender Requirements and Roth Conversions
Trying to make lemonade with the lemons that a mortgage company is giving my client who is looking to buy a home. She has $100k sitting in the bank; however, that isn’t good enough the lender is requiring that she begin taking withdrawals from her IRA. Bottom line, she doesn’t need to pull the money to live on (she is in the process of selling her current home which has plenty of equity for the down payment and monthly expenses). She will have to make at least 1 or 2 withdrawals of $7,000 to satisfy the lender. More than likely we are looking at two distributions separated by a month of time.
Would there be any problem taking a distribution from the IRA to satisfy the lender and then after the home closes (within 60 days) rolling that amount into a Roth IRA as a conversion? I know that the IRS very clearly states Roth IRA conversions can be accomplish by rollovers in a 60 day period. I am about 95% sure that these would be exempt from the 1 per 365 day limit for IRA rollovers. Only reason that I waiver is that I spoke to somebody in my custodian’s IRA distribution team and they said a 1099-R and 5498 would be issued. They said there was no guidance as to how the IRS would view the transaction. To me, the spirit of the law is to stop people from taking tax-free loans from their IRA, so this will not be an issue as taxes will be paid. But, any input would be welcomed.
Oh, why not do a 60-day rollover? Well, we do need to reserve that for the down payment of the new house. Proceeds from the sell of the current home will be used to pay back the IRA.
Permalink Submitted by Alan - IRA critic on Wed, 2015-07-15 22:11
There is no problem converting the two distributions to a Roth IRA within the 60 day deadline, however if the money is needed for a down payment subject to timing of the sale of the current home and cannot be rolled to a TIRA, how can it be rolled into a Roth IRA? Also, note that there is no limit on indirect 60 day Roth conversions, but if anything is rolled back into a TIRA only one such distribution can be rolled over within 12 consecutive months. Since she could not roll TWO 7k distributions over to a TIRA, if this is otherwise possible she needs to take one 14k distribution. Any plan that is contingent on the closing of the current home by a certain deadline is risky because any number of things could delay that closing and the 60 days could expire.
Permalink Submitted by Jimmy Rench on Thu, 2015-07-16 14:55
So taking two $7,000 distributions from an IRA and rolling them into a roth IRA within 60 days and also taking one $75,000 distribution from an IRA and rolling it back into that same IRA within 60 days should cause no tax issues?
Permalink Submitted by Jose Morales on Thu, 2015-07-16 16:13
You are only allowed to roll over one distribution for all IRAs within a 12 month period.
Permalink Submitted by Jimmy Rench on Thu, 2015-07-16 18:18
Understood, but the two smaller distributions aren’t actually classified as distributions. My understanding was that they would be classified as Roth IRA conversions.
Permalink Submitted by Jose Morales on Thu, 2015-07-16 20:30
Yes, that is correct. My apologies for not reading the previous posts.
Permalink Submitted by Jimmy Rench on Wed, 2015-07-15 22:32
We are only looking to roll the downpayment ($75,000 which would be the third and final distribution) back into the IRA. My client has a wealthy brother who is more than happy to make a short-term (bridge) loan to his sister. Unfortunately, if her brother makes the short-term loan prior to the closing of the house, it cannot be used as a down payment. The lender will not allow it. He is more than fine letting his sister borrow the money so that she can complete the 60 day rollover if the sale of her house should take longer. Ordinarily I would not advise jumping through so many hoops, but there is a substantial amount of capital gains that is currently in the 0% tax bracket.
Permalink Submitted by Alan - IRA critic on Thu, 2015-07-16 20:20
You are correct. The converted distributions do not count as rollover for purposes of the one rollover rule. Client could do the two indirect Roth conversions and still roll the 75k distribution back to a TIRA within 60 days. If the 14k is also being used to satisfy a lender requirement, I do not know if there will be problems if they find that this amount was converted rather than being left in a taxable account per their original requirement.
Permalink Submitted by Jimmy Rench on Thu, 2015-07-16 21:54
Thank you for the response. The lender simply wanted to see distributions taken from the asset that was going to cover the loan amount. A box to check on their end. Silly IMHO. The client is going to start Social Security in a year (age 70) and that income will more than cover the monthly mortgage. But I don’t write the rules.