401k Loan

[Guest jousty]

A participant in a plan took out loan for home purchase purposes which under plan provisions is allowable to be paid over 30 years. At closing the loan processing had not been completed and the participant took out money from savings to pay for the down payment required. The loan payment is then made to the participant and they use those funds for home repairs on their new home(In lieu of the savings they intended). Do the funds received for the loan have to be directly utilized in the purchase or will this work given its being a timing issue? Are they in breach of the plan provisions?

[Archimage]

What does the plan's loan policy say? Most loan provisions don't require the loan to be used for a specific purpose. However, I do realize that a lot of loan policies allow loans for hardship situations. Double check the loan policy to see which is the case here.

[E as in ERISA]

I assume that you are concerned because you can only exceed the 5-year requirement if it is a principal residence loan.

There are tracing rules in Q&A 7 of the 72(p) regulations. LINK: http://www.benefitslink.com/taxregs/72p-final.shtml .

They say you have to meet the tracing rules of 163(h)(3(B).

[Guest jousty]

163(h)(3)(B) states:

(B) Acquisition indebtedness

(i) In general

The term "acquisition indebtedness" means any indebtedness which - (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (II) is secured by such residence. Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.

(ii) $1,000,000 limitation

The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).

-So I read this to be in compliance on point(I), but possibly not point(II). Is there a problem if this is being contributed towards "substantially improving any qualified residence...", but is NOT directly tied to repayment of the home loan(point II), or am I misinterpreting "secured by such residence"?

[Archimage]

Sorry, but my last reply was written before I had my first cup of coffee. I see I was on a totally different tangent. I agree with Katherine on the tracing rules. Read IRS Notice 88-74 which the IRS issued for guidance on this subject.

[E as in ERISA]

Q&A 6 of the 72(p) regulations clarifies that the loan doesn't have to be secured by the residence.

I'd look more into whether you qualify under (I). I'd look at Regs. Sec. 1.163-8T and 1.163-10T.