Hardship request to buy out principal residence from other owner

A participant requested a hardship distribution to buy out his soon to be ex-spouse from their half of the principal residence.  There is no DRO involved here at this point.  The plan sponsor indicated they didn't see any problem with this request as a "purchase of principal residence" purpose for hardship.  The Plan Sponsor believes this is a purchase of his principal residence from the other owner.  I can't find anything anywhere to substantiate accepting or rejecting this request to use the funds to purchase a principal residence.

I realize a DRO request is the way to go here instead for a lot of reasons, but my question is can a participant request and obtain a "hardship" withdrawal to buy out a second owner of a principal residence?  He will be 100% owner at the end of the transaction.  What do you think?

I think this has been addressed on this board before, and with reference to informal IRS guidance.  I do not think a DRO is necessarily “the way to go” even though it could be achieved that way.  

what paperwork/documentation is he providing if not a DRO?  Is there a purchase contract or some written agreement?

And does he understand that with a hardship it is taxable to him, and possibly subject to the 10% early withdrawal penalty? With a DRO, the 10% penalty doesn't apply and it is taxable to the alternate payee.

QDROphile - you are right!  Apparently there was a 2004 Q & A from the ABA in a divorce situation where the IRS was ok with a hardship to purchase the property away from the ex-spouse. 

Anyway, I find your response really interesting.  I assumed (for exactly the same reasons K2 suggested) that the DRO was going to be better for the participant but it looks like you must have seen a situation where it was not.    

19. §401(k) – Hardship Distributions A participant wants to know if the purchase of principal residence qualifies as a hardship if she is using the proceeds to 'buy out' the equity on her current home from her exspouse?

Proposed response: Yes, because the dwelling is her principal residence and she is purchasing an interest in it that she didn’t own before.

IRS response: The IRS agrees with the proposed answer. The participant is purchasing a part of her principal residence.

So - to play devils advocate - could a participant take a hardship to make a mortgage payment? perhaps for the portion of the payment that is principal and not interest? They are "purchasing" that part of the home back from the bank. 

I've always said no - the participant should demonstrate foreclosure related paperwork, but perhaps I've been looking at it wrong. 

And would the answer be state specific? I understand in some states the lender has a much more protected right in the home than others, and may hold primary title, etc. I don't really know, i'm not real estate lawyer, but maybe someone else here does know. 

2 hours ago, justanotheradmin said:

So - to play devils advocate - could a participant take a hardship to make a mortgage payment? perhaps for the portion of the payment that is principal and not interest? They are "purchasing" that part of the home back from the bank. 

Using safe harbor definition?  No. 

2 hours ago, justanotheradmin said:

 

I've always said no - the participant should demonstrate foreclosure related paperwork, but perhaps I've been looking at it wrong. 

Costs related to the purchase of a primary residence and costs to prevent eviction/foreclosure are different hardships. For the latter, you are 100% correct to require that the participant prove foreclosure/eviction.

The mortgage interest is materially different from the undivided interest both legally and economically.  For example, acquiring the spouse’s interest results in the purchaser acquiring the entire property interest that the purchaser does not already own himself and divesting the spouse completely.  Also, the spouse’s interest is a fee interest, the mortgage interest is not, so it is not accurate to describe a mortgage payment as [re]purchasing that part of the house.  The analogy is not meaningful so the purchase rule informs nothing about the mortgage payment rule.

Another option may be to take loan if permitted by the plan. While not entirely clear, footnote seven of the 2000 preamble of the sec. 1.72(p)-1 loan regulations suggests a plan loan could be taken for a buy-out of a spouse's interest.  The footnote states that the tracing rules of section 163(h) apply, and refers to Notice 88-74.  Notice 88-74 says, "Regulations will also provide that, in general, debt incurred to acquire the interest of a spouse or former spouse in a residence, incident to a divorce or legal separation, will be eligible to be treated as debt incurred in acquiring a residence for purposes of section 163, without regard to the treatment of the transaction under section 1041 of the Internal Revenue Code."