We had a question come up at work a few weeks ago and I think it’s a good strategy that few people take advantage of. One of our customers, let’s call him Bob, wanted to buy a car for his grandson. Bob was due to receive a large settlement from a lawsuit in a month or so. His idea was to take a distribution from his IRA to pay for the car and repay the IRA distribution with the funds he receives from the settlement. Will this plan work??
Yes, it will. In general any amount distributed from an IRA is included in gross income by the recipient. However, the recipient may exclude any amount distributed from an IRA if the entire amount is subsequently paid (that is, rolled over) into a qualifying IRA not later than the 60th day after the day on which the distribution is received. As long as all the requirements are met, this is like getting a tax-free, interest-free loan for 60 days. The Internal Revenue Code limits these rollover contributions to one each year.
What happens if the settlement is delayed? If Bob runs afoul of the 60 day rule, the distribution he received from the IRA will be taxable to him. And, if Bob is younger than 59 years old, he will have to pay the 10% penalty tax on early withdrawal.
The Tax Court held in Bobrow, TC Memo 2014-21, that the one year limitation is not specific to any single IRA owned by an individual, but instead applies to all IRAs maintained by the taxpayer. This holding, in effect, means each taxpayer may make one tax-free rollover contribution each year, with the year starting from the date of the first distribution. Let’s go back to Bob. Let’s say Bob has IRA#1, IRA#2, and IRA#3 at the First State Bank and he chooses to take the money for the car out of IRA#1 on July 8 of this year. Bob will not be allowed another tax-free rollover until after July 8 of next year.
The holding in the Bobrow case disagrees with the information presented in IRS Publication 590, Individual Retirement Accounts. A few weeks ago the IRS announced that it will issue proposed regulations and change the information in Publication 590 to agree with the Tax Court’s decision in the Bobrow case. The old rules will continue to apply until January 1, 2015.