Plan Loan for Construction of House

[chris]

Any clearer guidance from IRS or DOL regarding whether a loan from a plan can be used for the construction (vs. acquisition) of a home? Plan participant has 50K in PSP account balance and wants to get a loan for 25K for purposes of building a house. Thanks for your help.

[No Name]

Are you asking whether the construction loan can be more than 5 years? We otherwise don't give a hoot as to what the purpose of a loan is.

[Lori Friedman]

Does the PSP have a specific provision that loans will be made only for financial hardship?

Or, are you referring to the I.R.C. Sec. 72(p)(2)(B)(ii) exception to the 5-year term rule? Prior to the amendment made by the Tax Reform Act of 1986, Sec. 72(p)(2)(B)(ii) provided an exception for "loans used to acquire, construct, reconstruct, or substantially rehabilitate any dwelling unit..." The language was broad enough to permit loans for construction and major renovations (but not minor renovations or ordinary repairs). The amended language is much less expansive: "any loan used to acquire any dwelling unit..." I believe that the exception to the 5-year rule is now limited to loan proceeds used to purchase a principal residence.

[E as in ERISA]

I think that the loan regs say to look at the tracing rules under 163. My recollection is that there may be some guidance there on these types of situations.

[chris]

I'm referring to the exception to the 5 year requirement, specifically, meeting the "acquire" definition. As I understand it, prior to amendment the Code language provided for the exception for "substantial rehabilitation, construction and acquisition" of a dwelling. The result of the amendment to the Code was that now it only says to "acquire" any dwelling....used as a principal residence.

[FundeK]

A 1986 amendment to the loan regs specifically removed wording relating to a construction loan; therefore I would assume a construction loan does not meet the definition of a principal residence. The principal residence loan exception states that the loan must be issued to acquire any dwelling unit that will be, within a reasonable time, used as a principal residence of the participant. I would not allow a loan for a construction. However, if the participant can prove the unit will be dwelled in within a reasonable period of time (90% constructed) I would approve it. Perhaps conservative, but it never hurts to CYA.

[Lori Friedman]

Katherine's right.

If you read Reg. Sec. 1.72(p)-1, Q&A 7, you'll be referred to the tracing rules of I.R.C. Sec. 163(h)(3)(B): acquisition indebtedness incurred for "acquiring, constructing, or substantially improving any qualified residence..."

There are several IRS private letter rulings concerning construction loans and the pre-1986 rules but, unfortunately, I couldn't find any rulings held under the amended law.

[E as in ERISA]

72(p) regs:

Q-7: What tracing rules apply in determining whether a loan

qualifies as a principal residence plan loan?

A-7: The tracing rules established under section 163(h)(3)(B) apply

in determining whether a loan is treated as for the acquisition of a

principal residence in order to qualify as a principal residence plan

loan.

163(h)(3)(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.

1.163-10T(p)(5) Residence under construction--(i) In general. A taxpayer may treat a residence under construction as a qualified residence for a period of up to 24 months, but only if the residence becomes a qualified residence, without regard to this paragraph (p)(5)(i), as of the time that the residence is ready for occupancy.

[chris]

Does following the tracing rules also mean that the loan has to be secured by the residence? Q & A #6 states that a residential loan need not be secured by the residence itself. Also, if the tracing rules are the guiding language don't they allow for a loan for exactly the same circumstances, e.g., constructing/substantially improving a residence, that were amended out of the Code language as a result of TRA '86? Not trying to be difficult but it looks like the conservative approach would be to not allow a loan for construction. Thanks for all the prior (and any future) replies.

[E as in ERISA]

As everyone seems to agree. The rules aren't clear. There are too many gaps. The conservative approach is to disallow it based on lack of clarity.

[Lori Friedman]

Such a circuitous discussion of what seemed to be such a simple question!

Now that we've sorted through the Code and regulations, I'd be very comfortable with the more assertive position -- permit the loan. The position is certainly reasonable and defensible. This is a matter of judgment, however, and not of fact. It would be nice to have some better guidance (Of course, it would also be nice to win the lottery).

[E as in ERISA]

I tend to agree. But I know I'm not going to convince someone who wants clear guidance on the issue -- when I'm pretty sure that there is none.

[Guest Grabitquick]

I've looked at this before and just kind of gave up when I saw the lack of symmetry between the tracing rules and the plan loan rules. Fortunately, the participant in the case that I recall also eventually gave up and decided not to apply for a loan after all since his/her account wasn't large enough to provide a loan that would make much of a dent in the construction costs.

[E as in ERISA]

Just noticed this from the 2003 ASPA Q&As at http://www.aspa.org/archivepages/conferenc...st/loans/qa.htm --

3.1 Can a residence loan be made for home construction or to purchase land?

Code Section 72(p) applies the rules of Code Section 163(h) to determine whether a loan is for a residence. Under Code Section 163(h), a loan to purchase land does not qualify. A loan used to pay for home construction may qualify, provided the construction is completed within 24 months and the home is then used as the participant’s principal residence, without an intervening use. See, PLR 8933018.