Managing your financial life is not just about money.

Being a Smart Buyer

From what I understand, the real estate market in some areas is quite competitive these days. In competitive markets, when sellers receive multiple offers, it’s important for buyers to be “attractive.” The most attractive buyer isn’t necessarily the one with the highest offer; it could be the one that doesn’t need a mortgage to purchase. One strategy that buyers can utilize (and realtors may even recommend) to position themselves attractively for a home purchase is to borrow from a retirement plan, purchase the property with cash, then obtain a mortgage after the purchase and put the money back into the retirement plan. If your head is spinning, it should be. In my professional opinion, this is not a good plan because if it’s not executed perfectly, you can end up owing significant tax dollars to the IRS and diminishing your nest egg.

Generally speaking, someone who needs a mortgage for a purchase would have a mortgage contingency clause in the agreement, which allows that buyer to back out of the transaction if the mortgage falls through. Imagine a situation in which there is one seller and two buyers. Both buyers offer the same amount of money for a house, but one buyer needs a mortgage to purchase and the other one doesn’t. So the first buyer needs a mortgage contingency clause to protect them should their financing fall through. The second buyer is paying cash and needs no such mortgage clause. All other things being equal, the second buyer is the more attractive one to the seller because the seller wouldn’t have to worry about the deal falling through for financing reasons.

Again, in fast moving real estate markets, buyers may be looking for creative ways to position themselves attractively without simply offering more money. Think of our buyer No. 1 above (the one who is using a mortgage to purchase), and let’s assume he wants a mortgage of $400,000 to buy the house. If he has at least that much inside of a retirement account (like a Rollover), he theoretically could withdraw the $400,000 from the IRA and purchase the house with cash (and likely win any bidding war because he is now a “cash buyer”). After the purchase, he is a homeowner, and he can apply for a mortgage on that same house he just bought for cash. As long as he was awarded the mortgage and puts his $400,000 back into the IRA within 60 days, there are no adverse consequences of withdrawing that money. The IRS allows one “60-day Rollover” per calendar year without any taxes or penalties due.

Now this all sounds like cupcakes and roses, but here’s the catch: if the timing doesn’t work out perfectly, our smiling buyer No. 1 could end up owing about $200,000 in taxes. Is he smiling anymore? If the bank doesn’t award him the mortgage quickly enough, and if he doesn’t get his money back into the IRA in 60 calendar days or less, then that full $400,000 withdrawal is taxable to him as regular income. Welcome to the 39.6 percent income tax bracket! Oh and if he’s younger than 59 ½, there is also a 10 percent penalty. Oh and if he lives in Massachusetts, there is a 5.3 percent state income tax on that as well. If you were adding that up, the taxes could be as much as 55 percent! And the last straw is that if he misses that 60-day deadline, he can’t get that money back into the IRA at all. He no longer has that $400,000 tax-deferred investment growing for his retirement; he has just $200,000 after he paid the rest to the IRS.


alyssa-cropped-colorAlyssa McNamara Reed, CFP™

Certified Financial Planner


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