Hardship Distribution for Purchase of Multiplex Building

[cathgrace]

Plan has the principal residence safe harbor provision. A participant is actively looking to purchase a multiplex building (4 units). He wants to live in 1 unit as his principal residence and lease the other 3 units. He is requesting a hardship distribution to purchase the building. Does this fall under the principal residence safe harbor for hardships? My concern is that the participant is technically purchasing more than his own residence. 

Any thoughts? 

[Peter Gulia]

Might the claims administrator evaluate whether the claimed need amount (before a gross-up for taxes on the hardship distribution) seeks no more than one-fourth (or another appropriate fraction) of a reasonable down payment (not the mortgage) to purchase the place that includes what would become the participant’s principal residence?

This is NOT advice to anyone.

[CuseFan]

I don't think it's an issue. I think Peter's 1/4 note merits some thought, but in that vein I could argue that any request (before tax gross-up) would only need to be limited to 1/4 of the purchase price. Say the property was selling for $400,000, you could argue that his residence is $100,000 of that and substantiate a hardship for that amount plus taxes. I don't see any reason he couldn't pay cash for 100% of his dwelling (or whatever he can obtain through hardship) while financing 100% of the other units. 

What about someone who purchases a condo or townhouse that has common areas or pools of which they purchasing a portion (are they not?) so technically not all of their cost is attributable to their "residence". 

[Paul I]

Part of the challenge is the remaining 3/4 of the purchase likely is going towards an income-producing investment.  The individual will not be able to treat the entire building as a residence when preparing the individual's income taxes.  The personal income tax reporting rules may be illustrative in how to determine what is a personal residence and what is an investment property.

[Peter Gulia]

That might leave some interpretation questions for the claims administrator.

[Belgarath]

One reason why I love self-certification! Barring further guidance/regulation, of course. The participant is signing off, and there's no reason for the Plan Administrator to question what it is for! And no reason for the participant to tell the PA what it is for. If it ain't legit, and the IRS comes after the participant, so be it - not the PA's problem.

[Paul I]

I agree that right now there is unrestrained availability to rely on self-certification unless or until the IRS issues regulations where the PA has actual knowledge that the reason for the hardship is not valid.

This leaves us with an open question:  What would the IRS do should they audit an individual's tax return and determine that the hardship distribution did not meet the terms of the plan?

The participant already is paying taxes on the amount withdrawn. 

Presumably, the participant already would have spent the distribution on some major expense.  Could the IRS force the participant to return the invalid hardship to the plan?

Currently, there does not seem to be any exposure to the plan if the plan receives the self-certification.  As a permissible distribution having received the self-certification, it would be hard to argue there hardship distribution was a prohibited transaction.  Certainly, plan disqualification would be ridiculously punitive to everyone else in the plan for the actions of one participant.

This must be a nightmare for those who are concerned about leakage from a plan.

[Belgarath]

I'm only speculating - seems like the relaxed hardship standards might be a combination of legitimately making it easier for participants and plan administration, AND, whether openly acknowledged by Congress or not, a Revenue raiser. But I'm very cynical about Congress these days, and attributing this possible motive may be an absurd thought. 

 

[Peter Gulia]

The Joint Committee on Taxation estimate [JCX-21-22 (Dec. 22, 2022)] scored the hardship self-certification provision as raising only $358 million for fiscal years 2023-2032.

While one cannot read the mind of a Member of Congress, here’s another explanation:

The SECURE 2022 provisions for accepting a claimant’s statement about her hardship or unforeseeable emergency approximate what already has been the situation with many plans. Participants learn, often quietly and quickly, how to mark a website app or paper form to state a claim the service provider processes in good order with nothing that requires any further instruction from the supervising fiduciary.

[Patricia Neal Jensen]

I do understand, Peter, what you are saying, but the term "claims administrator" is  unfamiliar.  Just an FYI.

Patricia

[CuseFan]

I believe he means the Plan Administrator or it's designee authorized to evaluate and administer benefit claims for the plan.

[Peter Gulia]

As CuseFan says.

Some retirement plans have only one administrator, and the one decides everything that calls for a discretionary decision.

Yet, some retirement plans have a top-level administrator and ERISA section 405 allocations of distinct fiduciary responsibilities to one or more claims administrators, each for a specified set of kinds of claims. For example, some plans I work with contract an administrator for claims that a participant is entitled to a distribution (whether by hardship, severance from employment, age, or another reason), and another separate administrator for claims that a court order is a qualified domestic relations order.

[BG5150]

On 7/24/2023 at 3:46 PM, CuseFan said:

would only need to be limited to 1/4 of the purchase price.

This is assuming all four units are the same size and are worth the same.  (Would an end unit or higher floor unit be worth more than the others?  Less?)

Also you don't absolutely know if the owner will live in only one unit.  maybe they will decide to tear down a wall and occupy two of the units.

 

[cathgrace]

Thanks everyone for your responses! In case anyone is wondering, the plan administrator ultimately decided to approve the hardship distribution for 1/4th of the amount of the purchase price of the building.