The $2,000 they used for the purchase of their first home is not subject to the 10% penalty under IRC section 72(t)(2)(F).

Franklin, you may want to invest in some punctuation and capitalization. Pretty hard to follow you.

How does a contribution reduce the penalty? It reduces the taxes, not the penalty.

Helen, EA in PA

I’m not sure the exemption would be limited to $2,000 – or as much as $2,000. Do you mean the $2,000 was the only portion of any payments the clients made that were traceable directly to the IRA distribution? Or do you mean the clients only paid $2,000 in qualifying expenses? Are you reducing the IRA exclusion amount by the tax credit? Did the purchase meet the requirements for the exception to the 10% penalty tax? See page 53 of IRS Pub 590 for the requirements
http://www.irs.gov/pub/irs-pdf/p590.pdf

He only used $2000 for the purchase of the house. Why he took out all of that money is beyond me. He stated he invested in a cd paying about 2%. There is nothing I can do with clients who don't think right.

Mitch

You say "out of their retirement account" -- what kind of account was it?

If they took it out of their 401(k) or similar plan, then NONE of it qualifies for the exclusion.

If they took it from an IRA and did not own a house in the past two years, then up to $10,000 is potentially excludable.

Did they put down more than $2,000 in cash? If yes, you might be able to argue that more than $2,000 went towards the house, even though the money did not go directly from the IRA to the seller. For instance, if they made a $10,000 down-payment from their checking account on Monday and deposited the $25,000 from the IRA on Wednesday, I would consider taking that position.

Thanks Tom. I sent the client his tax return and excluded the $2000 he used for buying the house. However I looked at the 1099r and it was a 401k. I have to get back to my client and revise his taxes

Mitch

I agree that the 2000 would not be subject to the penalty and as to the rest if within the 60 period redeposit other wise pay the penalty. they can also redeposit the bal and call it a 2009 contribution and the reduction will help to offset the penalty in the computation of the total tax. From a financial point of view if in a 10-15 bracket open an Roth IRA pay the tax penalty when it matures after 5 years the rate will probably be higher and they will more than likely be dollars a ahead in the long run. Its not really smart to have an ira to save 10-15% and then take rmd's to pay 25% or greater.