Loan to acquire principal residence, deal falls through

[Belgarath]

This happens sometimes. Let's assume the individual promptly repays the loan amount, plus interest for the few days he had the funds. Now 2 months later, set to buy a house again.

Would you treat the first loan as "never happened" for purposes of the subsequent loan limits, or would you treat it as part of the highest outstanding balance in the last 12 months? I lean toward to former, as the latter seems to produce a truly unfair result, but one could argue that the latter is more technically correct.

Opinions?

[Mr Bagwell]

Was there a fee involved for the first loan?

[Belgarath]

What kind of fee? Do you mean something like a TPA or recordkeeper fee of $75 to originate the loan?

[Mr Bagwell]

Yes. 

I don't have a strong opinion on this.  My sarcastic side says that if the "never happened" loan had a fee attached to it, it happened.

Is this employee an HCE and a NHCE wouldn't get the same benefit if needed?

And of course, there is not enough balance to secure the needed amount of new loan.....?

[Kevin C]

I would not ignore the loan.  Taking a loan in excess of the 72(p)(2)(A) limit results in a taxable deemed distribution.  I don't see an exception in the regs for this situation, so the prior loan balance counts in the calculation.  Ignoring the loan would mean intentionally treating a taxable amount as not being taxable. There is an unpleasant term for that.   In this case, it's don't make the participant's problem your problem.  The participant could have held the loan proceeds, made the scheduled payments and used the remainder when they found another house.

 

Suppose you do ignore the rules in this case?  What about a participant who borrows to pay for his daughter's wedding and it gets cancelled after the loan?  Will you do the same if they reconcile and get married a few months later?  What about a loan to fund college expenses when the student drops out after the loan and then goes back the next semester? I could come up with more examples, but you get the idea. 

 

[RatherBeGolfing]

2 hours ago, Belgarath said:

Would you treat the first loan as "never happened" for purposes of the subsequent loan limits, or would you treat it as part of the highest outstanding balance in the last 12 months?

Fee or no fee, the loan happened.  Kevin beat me to it but there is clearly no exception to it in 72(p) and I don't think an auditor would agree with treating it as never happening because it clearly did.  Its no different than the doctor who needs some quick liquidity and needs $50k and repays it all a week later only to come back for another $50k loan 6 months later.  That the house purchase fell through after the loan was issued is immaterial.  Presumably, the participant is looking for another home to buy and can use the money s/he already borrowed from the plan for the new home.

The IRS has clarified (informally, but still) that if a participant takes a hardship for the purchase of a home, and the deal falls through, the hardship distribution stands.  It was a proper hardship at the time of distribution, and there is no process through which the plan can accept the money even if the participant wanted to return it. I see no reason why a loan should be treated differently.

[jpod]

I agree that the participant did not have to repay the loan, but since he did he's stuck.  Hope I can remember this lesson so I can give a proactive warning in case it ever comes up in my practice.    

[QDROphile]

If you are interested in protective practices, for both hardships and loans for home purchases, the distribution/loan arrangement should be included in the closing escrow for the home purchase, with appropriate conditions and escrow instructions. If the sale fails, there is a much better (I think winning) argument that the conditions of the distribution/loan were not satisfied, so there was no distribution or loan.  The return of funds to the plan is not reversing a distribution or repaying a loan.  Of course, this requires real plan administration, not the automated, no brain, arrangements that many employers get with the bundled package of documents and services.

[Larry Starr]

7 hours ago, Belgarath said:

This happens sometimes. Let's assume the individual promptly repays the loan amount, plus interest for the few days he had the funds. Now 2 months later, set to buy a house again.

Would you treat the first loan as "never happened" for purposes of the subsequent loan limits, or would you treat it as part of the highest outstanding balance in the last 12 months? I lean toward to former, as the latter seems to produce a truly unfair result, but one could argue that the latter is more technically correct.

Opinions?

Not even close. The loan stands; it happened. You are stuck because those are the rules.

[Belgarath]

Thanks all. Now, suppose he doesn't repay the loan. Can he still take the full 15 years to repay it? Or must it be renegotiated for a 5 year period? I've seen different opinions on this - personally, I don't think the Plan Administrator has a legal duty to follow the results of the loan, as long as it was properly documented and granted as a legitimate home loan. However, the EOB indicates that "best practices" would require a Plan Administrator follow-up, and the loan should be "recalled" or restructured for 5 years. This is in line with Qdrophile's comments.  I don't think that happens much in real life, however.

[RatherBeGolfing]

1 hour ago, Belgarath said:

personally, I don't think the Plan Administrator has a legal duty to follow the results of the loan, as long as it was properly documented and granted as a legitimate home loan.

I don't think so either.  It was a proper loan at the time it was issued, with a 15 year amortization schedule.  If we agree that a proper loan took place, I don't see how the plan admin can recall the loan unless the loan docs include language that addresses the issue. 

[CuseFan]

On 8/31/2018 at 3:52 PM, Kevin C said:

The participant could have held the loan proceeds, made the scheduled payments and used the remainder when they found another house.

That is exactly what should have been done had the participant (or plan administrator) known the rules, but barn door was open, the horse got out and ate the flowers, and even though back in the barn now cannot un-eat the flowers.

[Larry Starr]

2 hours ago, RatherBeGolfing said:

I don't think so either.  It was a proper loan at the time it was issued, with a 15 year amortization schedule.  If we agree that a proper loan took place, I don't see how the plan admin can recall the loan unless the loan docs include language that addresses the issue. 

Agreed.

[ricopenthouse]

Nice horse analogy :). Please tell me if I got this right. Basically, you can request a bank loan, for example, to buy a house. Having got the loan, you use the money and buy the house above. In a few days, you find yourself in possession of a large sum of money and choose to pay the loan. Having done so, even if you had paid some interest rates for the time you had the money, you are considered loan free and as if you had never had a loan? I asked a friend from Mortgage Advice Newcastle to explain it to me, but the terms were too complicated to understand.