IRA Alert

Roth IRA can affect homebuyer credit

A poorly timed conversion, or claiming credit in wrong year, can cause a loss of tax reduction

Jan 3, 2010 @ 12:01 am

By Ed Slott

The latest version of the tax credit for first-time homebuyers has two new features that may make the credit more widely available, which means more clients with Roth conversion income may be affected.

Under the Worker, Homeownership and Business Assistance Act of 2009, which took effect Nov. 6, the actual tax credit amount can be as high as $8,000, or $6,500 for the new alternate version of the tax credit. Either way, that's a lot of money to most of your clients.

A tax credit is more valuable than a tax deduction since it is a dollar for dollar reduction of any tax due. It is like actual cash received. A tax deduction, on the other hand, merely reduces the amount of income subject to tax.

Since a tax credit is so valuable, you'll want to make sure you know which clients may be eligible for the credit and tailor planning to take maximum advantage of both the full tax credit and of the new 2010 Roth individual retirement account conversion opportunities. You don't want a situation where a poorly timed Roth conversion, or taking the tax credit in the wrong year, causes the loss of that credit. Avoid nasty surprises and evaluate each client's situation carefully.

The credits now phase out with modified adjusted gross income of between $125,000 and $145,000 for single taxpayers and between $225,000 and $245,000 for couples filing jointly.

Previous law defined a first-time homebuyer as someone who hadn't owned a principal residence for the three years prior to the new purchase. The new law retains this definition and offers a tax credit of 10% of the home's purchase price, up to an $8,000 credit, but the credit is completely lost if the purchase price exceeds $800,000. The law also creates a new credit that's capped at $6,500 for long-term homeowners. New homebuyers are eligible if they previously owned and resided in the same home for at least five consecutive years out of the previous eight. The income limits are the same as those for the $8,000 tax credit.


What does all this have to do with IRAs? Advisers should be aware that IRA distributions of pretax dollars will increase a client's modified adjusted gross income. Some clients qualify for the credit for tax year 2009 because there were no required minimum distributions last year. As of this writing, RMDs are back in 2010 and beyond. If your clients must take distributions from their IRAs this year, that amount may put them over the income threshold to qualify for the homebuyer tax credit in 2010.

A surge in Roth IRA conversions is likely this year. Such events trigger taxable income that must be taken into account when planning for the first-time homebuyer credit. Fortunately, there are some tactics that can help combine savvy IRA planning with the credit.

For either the $8,000 or the $6,500 tax credit, an eligible client must buy the principal residence by April 30. (If a binding contract is in place by then, the sale can be closed as late as June 30.)

Even if the sale is completed this year, the tax credit can be claimed on either a 2009 or a 2010 tax return. Therefore, your client might choose whichever of those two years has the lower MAGI, if that means getting a larger tax credit — or even getting one at all. A client who takes an RMD in 2010 that puts him over the MAGI limit might still be able to claim the credit on his tax return for 2009, when there were no RMDs.

For clients who intend to do Roth conversions in 2010, the taxable income can either be reported entirely in 2010 or split evenly between 2011 and 2012. Those choosing to report the conversion income in 2011 and 2012 may be able to use the tax credit this year, when income might be lower. On the other hand, higher tax rates in 2011 and 2012 might make it worthwhile to pay the tax on a Roth IRA conversion at this year's tax rates and then take the tax credit for tax year 2009.

Advisers need to identify and contact all clients that could be eligible for the first-time homebuyer tax credit and advise them that the tax credit can be taken in 2009 or 2010, even if the home is purchased in 2010. Make sure to evaluate the effects of a Roth conversion or a required minimum distribution on the tax credit to help the client optimize both the tax credit and the Roth conversion, by choosing which year to claim the credit and which year (or years) to report the 2010 Roth conversion income.

Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at

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