One of the participants in our 401(k) plan submitted a request for a hardship distribution for the purchase of a primary residence. On review of the supporting documentation, we discovered that the purchase has already occurred and that the requested distribution is to cover the cost of renovations prior to moving in.
How strictly does the IRS interpret what costs qualify as being associated with the purchase of a primary residence? Is there any wiggle room that would allow renovation costs to qualify for a hardship withdrawal for purchase of a primary residence?
The rules are fairly strict here. In order to qualify for a hardship distribution, the amount requested must be necessary to cover costs directly related to the purchase itself and not improvements to the home after purchase. However, there are some nuances to consider:
We came across an interesting twist on this theme a few years ago. A participant was renting a home, the landlord was way behind on mortgage payments, and the bank was about to foreclose on the house and evict the participant in the process. The participant requested a hardship distribution to make the landlord’s mortgage payments in order to prevent eviction; however, since it was the landlord and not the participant who had the financial need, the request was denied. When the participant decided to purchase the home from the landlord before the bank could foreclose, the participant was able to take the hardship distribution for the purchase of his primary residence.
Although many hardship distributions are straight-forward, many can be extremely subjective, and there are plenty of gray areas. While it can be tempting to push the limits in order to help out a participant in dire financial straits, keep in mind that pushing too far can, at worst, jeopardize the entire plan for all of the participants. At a minimum, correcting the errant hardship distribution can prove quite costly to all involved.
For more information on hardships and distributions in general, please visit our Knowledge Center here.