Hardships -- Primary Residence Purchase

[Guest erisafried]

I know what the answer ought to be to this question, but I wondered if anyone has any thoughts about what the answer actually is. Here it is:

A participant in a 401(k) plan wants to take a hardship distribution to fund the costs of acquiring a principal residence. The twist is this: the participant is in the center of the universe (a/k/a New York City) and the residence at issue is not a regular apartment or house -- it's a co-op. Apparently, one does not actually "buy" a co-op but instead buys shares in the non-profit corporation that owns the building in which the co-op is located. The "buyer" is then able to live in a specified unit and pays "rent" to the corporation -- I gather that the rent is basically the equivalent of a homeowners' association fee and covers routine maintenance, some utilities, trash pick-up, etc.

You'd think that this would count as a principal residence purchase even though the participant is not actually getting a mortgage attached to a specific piece of property. I haven't been able to find any specific IRS authority on point, however. This may not be a particularly wide-spread issue since co-ops don't seem to be prevalent outside of NYC. Perhaps no one has ever asked the IRS for guidance.

In any event, if anyone has ever wrestled this one to the ground, I'd appreciate hearing about it.

Thanks!

[Lori Friedman]

This is something that's very frustrating about hardship distributions -- the law provides broad and general explanations of what constitutes a permissable distribution, but there's little or no guidance about specific circumstances.

Under Reg. Sec. 1.401(k)-1(d)(3)(iii)(B)(1), a plan can make hardship distributions for costs directly related to the purchase of a principal residence. Yet, the term "principal residence" isn't defined in the context of I.R.C. Sec. 401(k).

My opinion -- look elsewhere in federal tax law for what qualifies as a principal residence. I.R.C. Sec. 121 is the law that entitles a taxpayer to exclude part or all of the gain from a sale of a principal residence. For the purposes of this Code section, a principal residence includes a house or apartment that the taxpayer is entitled to occupy as a tenant-shareholder in a cooperative housing corporation [Reg. Sec. 1.212-1(b)(1)]. Because Sec. 401(k) leaves us hunting for a definition of "principal residence", this is the one that I would use.

NOTE: A "cooperative housing corporation is defined in I.R.C. Sec. 216(b)(1) and (2).

[masteff]

the participant is in the center of the universe (a/k/a New York City)

My preliminary answer is no because the participant is a da.. er.. darn Yankee.

The long answer is that "principal residence" is not fully defined and therefore becomes a facts and circumstances test. One classic rule of thumb is whether it has a kitchen, sleeping area and bathroom. It is further worth observing that many of the tax benefits of home ownership are extended to unit owners in cooperative housing corporations. One general requirement for deductions under Code Sec 216 is that 80% of the co-op's income must be from tenant-shareholders (versus non-shareholder renters). (This is why many co-ops have strict rules against renting of units.)

For further example, in the regs on gain on sale of a principal residence in Reg Sec 1.121-1(b)(1), it says:

(b) Residence—(1) In general. Whether property is used by the taxpayer as the taxpayer’s residence depends upon all the facts and circumstances. A property used by the taxpayer as the taxpayer’s residence may include a houseboat, a house trailer, or the house or apartment that the taxpayer is entitled to occupy as a tenant-stockholder in a cooperative housing corporation (as those terms are defined in section 216(b)(1) and (2)). Property used by the taxpayer as the taxpayer’s residence does not include personal property that is not a fixture under local law.

So I would say yes, but for the sake of due diligence I might make the participant get a letter from the co-op stating that its unit owners generally meet the requirements for deductibility.

Opps, Lori got in right before me. Sorry for any duplication

[Lori Friedman]

One classic rule of thumb is whether it has a...bathroom.

Hey...what do you have against outhouses?

[Belgarath]

Up here in BoSox (God's) country, meaning NORTH of Boston, those are called "backhouses." We're going to build a fortified line from Boston to Buffalo to keep out the Yankee fans. We'll call it the "DiMaginot Line."