tax consequences of liquidating retirement question

7 Replies

Hello Wise Tax Professionals,

Quick question for you. I'm not actually in a position to do the below, but I'm going to be a hypothetical person with a crap ton of money in retirement accounts, a mix of 401k and IRA.

- I want to be a cash buyer to get the cash buyer's discount and pick of the litter of homes.

- I can do it only by liquidating my retirement accounts.

- OK, great, I do that and close on the cash purchase at a discounted price.

- I line up a rockstar lender and get a FNMA Delayed Financing Exception cash out refinance, and about X days after liquidating my 401k and IRA to purchase the home, I now deposit all the liquidated funds right back into those same retirement accounts.

- Once I live there for 2 years, I get the Sec 121 exception, meaning that instant equity from the discounted price will effectively be tax free income for up to $250k single / $500k married, when/if I go to sell.

Questions...

I've heard folks say that if you re-deposit it within 60 days (and have a tax professional do the relevant paperwork), there are no tax consequences. Is that accurate? Is that for 401ks, IRAs, or both? Are Roth 401k/IRAs any different? Does anyone know about the California employee retirement accounts, CalPERS etc? What about TSAs? Aside from Sec 1031 being applicable instead of Sec 121, will it matter if this is for an investment property? 

Thanks!

I do know you can borrow money from a 401K. I believe the max is 50K and it has to be paid back within five years. The retirement plan guys can chime in with much better info. You possibly COULD convert to a Roth, but I believe you will have to pay the penalty. Once you have a Roth, all growth is tax free but you have to wait until you are an old man to take it out:)

Chris,

Why don't you just set up a Self Directed IRA or Solo 401K Trust (if that type of entity is permissible). Then transfer or rollover the existing IRA or 401K funds into that new Self Directed Retirement entity/account. Then when that hot deal comes along, just pay cash from the SDIRA. If you want, you can later leverage that home or rental asset in the retirement account with a non recourse loan and put that money back into the self directed retirement account so that there are now more funds for future investments. There are several providers of self directed retirement accounts that frequent Bigger Pockets, or do your research and find the best fit for your plan.

Originally posted by @John Thedford :

I do know you can borrow money from a 401K. I believe the max is 50K and it has to be paid back within five years. The retirement plan guys can chime in with much better info. You possibly COULD convert to a Roth, but I believe you will have to pay the penalty. Once you have a Roth, all growth is tax free but you have to wait until you are an old man to take it out:)

John is mostly correct on the Roth IRA. If it's a regular IRA that you get a tax deduction for contributing to, moving it to a Roth would be taxable. The benefit is it would grow tax free. Converting to a Roth shouldn't create a penalty as it's still a conversion but the money has to stay in the Roth IRA and it is taxed as ordinary income. One other difference is that once that money has been contributed it can be taken back out later once you've had the account open for five years.

There are ways to take money out of a Roth IRA that are tax free. First time home buyers and higher education expenses are examples of ways to take earnings out that are tax free as well.

@Chris Mason

The process you refer to is a 60-day rollover. It is generally a bad idea because of the risk if you do not return the funds to an IRA within 60 days. Speak with your CPA, who will likely talk you out of recommending this to your investor clients.

You are limited to one such transaction within a 12 month period - so only one account, not multiple.  A current employer plan would not allow for the distribution in the first place.

@Chris Mason

@Brian Eastman summed it up pretty well. While you might be able to take a such a distribution from a current employer plan depending on the plan document, the type of contributions you've made, and the earnings, it is more likely that one of those factors would make this infeasible. The big issues are the risk of not getting the funds back in the account on time and the 12 month limitation. Both are reasons that a direct transfer is usually recommended instead of the 60 day rollover when someone is moving funds. Of course for your purposes, the 60 day window is what you're trying to leverage to acquire property as a cash buyer. You're not trying to move funds. I believe this line of thinking is why the IRS limits the 60 days rollovers to once in a 12 month period. You hypothetical is within the realm of possibility, but most advisors would probably caution you against it.

@Chris Mason

The answers you received were right on with lots of warnings. If you wanted to do the scenario you discussed this is how I would do it. 

Combine your accounts into one with enough money to purchase the property. Use transfer and direct rollover paperwork- this is important because you can have as many transfers and direct rollovers as you want. (Custodian to custodian)---Roth or traditional IRA. Take out your IRA $$$ at closing and use your rock star lender for delayed closing finance. As @Brian Eastman says Better be less than 60 days. Pay back Ira and live in house for 2 years.

Then sell it as you propose. End result money is back in IRA and you have profit from house tax free. Seems like a lot of work.

You do not pay a penalty to convert to a Roth but you do pay the tax at your tax rate. You can take contributions out at anytime without penalty or tax-5 years old or not. 5years has to do with earnings not contributions. 

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