Participant Loan Refinance - Stop the madness!

[Doghouse]

Any thoughts on the following situation would be much appreciated. I'm getting a headache.

1/1/2009 participant takes out general purpose loan, term 5 years.

1/1/2010 participant refinances this loan as a principal residence loan, term 10 years.

5/1/2013 participant requests to refinance this loan again, for a new principal residence. Additional principal will be borrowed. The 10 year maturity date from the first refinance will be retained.

Some additional facts:

Vested account balance including all outstanding loan balances = $80,000

Outstanding loan balance immediately prior to new refinance request = $24,000

Highest outstanding balance in prior 12 months = $26,000

Is this new refinance permissible? I would be a lot more comfortable with it if the original loan hadn't been for a 5 year term.

Dog

[masteff]

What additional principal can be borrowed? The current balance is equal to the max allowed by the statutory loan limit.

$50,000 - $26,0000 (highest bal in prior 12 months) = $24,000

http://www.irs.gov/Retirement-Plans/Loan-Limits-Apply-to-All-Plans

[Doghouse]

I think the issue is whether both the replaced loan and the replacement loan must be treated as outstanding for the purposes of the 72(p) limit. It is obviously not always the case that they are.

[BG5150]

Plus, you have to make sure the original loan is paid off w/in on or before its 5th anniversary.

There's an example in the EOB.

[MoShawn]

I have to disagree:

If the initial refinancing in 2010 was calculated and structured correctly, then the initial 5 year loan would be considered paid off and have no bearing on the current refinancing.

There is another step to the calculation that masteff used. The $50,000 limit is reduced by the highest balance outstanding in the last 12 months, less the amount outstanding on the day of the new loan. In this instance that would be $50,000 - ($26,000 - $24,000) = $48,000.

The other half of the limit would be the 50% of vested balance less current outstanding balance calculation. Again, in this instance that would be ($80,000 * 50%) - $24,000 = $16,000.

The tricky part is that this could be reduced to an even lower amount if the term of the loan extends beyond the term of the loan being replaced. There is a special rule noted in the EOB Chapter 7, Sec. IX, Part C.3.c. about refinancing a principal residence loan. It implies that any additional money borrowed would disqualify the loan from a repayment period greater than 5 years.

However, if the additional money also qualifies for the principal residence exception ... even Sal notes that it is not clear.

You may need to do as the EOB says and look to the tracing rules of IRC 163(h)(3)(B) to see how the IRS would view it.