3673 / How are amounts distributed from a Roth IRA taxed?

(1)   It is made on or after the date on which the individual attains age 59½.

(2)   It is made to a beneficiary (or to the estate of the individual) on or after the death of the individual.

(3)   It is attributable to the individual’s being disabled (within the meaning of IRC
Section 72(m)(7)).

(4)   It is a “qualified first-time homebuyer distribution” (see below).

A “qualified first-time homebuyer distribution” is any payment or distribution that is used within 120 days after the day it was received by the individual to pay the qualified acquisition costs of a principal residence for a first-time homebuyer.² The aggregate amount of payments or distributions received by an individual from all Roth and traditional IRAs that may be treated as qualified first-time homebuyer distributions is limited to a lifetime maximum of $10,000.³ The first-time homebuyer may be the individual, his or her spouse, or any child, grandchild, parent, or other ancestor of the individual or his or her spouse. A first-time homebuyer is further defined as an individual (and, if married, such individual’s spouse) who has had no present ownership interest in a principal residence during the two year period ending on the date of acquisition of the residence for which the distribution is being made.⁴ The date of acquisition is the date on which a binding contract to acquire the residence is entered into or the date construction or reconstruction of the residence begins.⁵ Qualified acquisition costs are defined as the costs of acquiring, constructing, or reconstructing a residence, including reasonable settlement, financing, or other closing costs.⁶

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Planning Point: Although the first-time homebuyer exception allows a taxpayer to avoid paying taxes on earnings, an individual should consider the non-tax consequences of such a distribution. There is an “opportunity cost” associated with taking early distributions. By taking a distribution from a Roth IRA, the Roth funds are depleted and the individual could lose out on significant account growth over time.

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In calculating the five-taxable-year period, it is important to remember that contributions to Roth IRAs, as with traditional IRAs, may be made as late as the due date for filing the individual’s tax return for the year (without extensions) ( Q 3655). For example, if a contribution is made to a Roth IRA between January 1, 2025 and April 15, 2025 for the 2024 taxable year, the five-taxable-year holding period begins to run in 2024.

For purposes of determining whether a distribution from a Roth IRA that is allocable to a “qualified rollover contribution” ( Q 3662) from a traditional IRA is a “qualified distribution,” the five-taxable-year period begins with the taxable year for which the conversion applies. A subsequent conversion will not start the running of a new five-taxable-year period.⁷

The five-taxable-year period for determining a “qualified distribution” is not recalculated on the death of the Roth IRA owner; the five-taxable-year period of the beneficiary includes the period the Roth IRA was held by the decedent.⁸

Any nonqualified distribution will be includable in income, but only to the extent that the distribution, along with all previous distributions from the Roth IRA, exceeds the aggregate amount of contributions to the Roth IRA. For this purpose, all Roth IRAs are aggregated. To the extent such distributions are taxable, the 10 percent early distribution penalty may apply
( Q 3677). Distributions allocable to “qualified rollover contributions” ( Q 3662) will be subject to the early distribution penalty regardless of whether the distribution is taxable if the
distribution is made within the five-year period beginning with the tax year in which the contribution was made.⁹ Distributions of excess contributions and earnings on these contributions are not qualified distributions.¹⁰

When a Roth IRA contains both contributions and conversion amounts, there are ordering rules that apply in determining which amounts are withdrawn. In applying the ordering rules, traditional IRAs are not aggregated with Roth IRAs. All Roth IRAs are aggregated with each other. Regular Roth IRA contributions are deemed to be withdrawn first, then converted amounts second (in order if there has been more than one conversion). Withdrawals of converted amounts are treated first as coming from converted amounts that were includable in income. The ordering rules treat earnings as being withdrawn last after contributions and converted amounts.¹¹

An individual may recognize a loss on a Roth IRA, but only when all amounts have been distributed from all Roth IRAs and the total distributed is less than the individual’s unrecovered Roth IRA contributions.¹² The deduction for the loss was typically a miscellaneous itemized deduction, but all miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025.¹³

A transfer of a Roth IRA by gift would constitute an assignment of the Roth IRA, with the effect that the assets of the Roth IRA would be deemed to be distributed to the Roth IRA owner and, accordingly, treated as no longer held in a Roth IRA.¹⁴

For the estate tax marital deduction implications of distributions from a Roth IRA, see Q 3713.