Early withdrawal of Keogh funds

I have been in practice for three years. Last year, I established a Keogh plan so that I could make tax-deductible, retirement-plan contributions. I recently got married, and we are in the process of buying our first home. Recently, I read that the new tax law allowed a first-time homebuyer to withdraw up to $10,000 from retirement accounts for purposes of making a downpayment without penalty. Can I use a portion of my Keogh contribution in order to take advantage of this?

Charles Blair, DDS

John McGill, MBA, CPA, JD

I have been in practice for three years. Last year, I established a Keogh plan so that I could make tax-deductible, retirement-plan contributions. I recently got married, and we are in the process of buying our first home. Recently, I read that the new tax law allowed a first-time homebuyer to withdraw up to $10,000 from retirement accounts for purposes of making a downpayment without penalty. Can I use a portion of my Keogh contribution in order to take advantage of this?

Unfortunately, you can`t. Section 72 (t)(2)(F) of the tax law does not apply to withdrawals from corporate retirement plans or Keogh plans. It is restricted to IRA accounts, which include SEP (Simplified Employee Pension) IRAs and SIMPLE (Savings Incentive Match Plan For Employees) IRAs, as well as the regular and Roth IRAs.

The 10 percent penalty normally applicable to early withdrawals from IRA accounts is waived if the funds are used to buy or build a home for yourself, a child, grandchild, parent, or grandparent. However, federal and state income taxes still will be owed on the withdrawal, so this strategy should be used as a last, rather than a first, resort.

In order to qualify, neither you nor your spouse must have owned a principal residence during the past two years. Furthermore, while you can make more than one withdrawal for this purpose, the total withdrawals over your lifetime cannot exceed $10,000.

I am planning to sell my practice, along with my office building, to my current associate. I was discussing this matter with my CPA recently, and he told me that part of the gain from the sale of my office building would not be taxed at the 20 percent maximum rate for long-term capital gains. Since I`ve owned this building for 30 years, how can this be?

The 1998 Tax Act provides that, as a general rule, all real estate held for more than 12 months will qualify for the 2 percent maximum tax rate on long-term capital gains. However, there are two important exceptions that probably will apply to you. First, if you have taken accelerated depreciation on the office building, the excess depreciation over what would have been allowed on a straight-line basis is taxed as ordinary income. In addition, the remaining amount of depreciation deductions previously taken (unrecaptured Section 1250 gain) is taxed at a maximum rate of 25 percent. Amounts that you receive in excess of your original cost for the property will be the only portion of the gain that will be eligible for the 20 percent maximum tax rate.

A vacant lot I own next to my dental office building was condemned by the city to create a park. While I paid $20,000 for the lot, I received $50,000 from the city as part of the condemnation proceedings. Must I pay capital-gains taxes on my $30,000 gain, or can I defer it by reinvesting?

Assuming that you held the adjacent lot for business or investment purposes, Section 1033 of the tax law allows two years in which to reinvest the proceeds in similarly held real estate. Assuming that you reinvest the entire $50,000, none of the $30,000 gain would be recognized, and the basis in the new property would be the same as the old ($20,000). If you reinvest less than the entire amount, a pro rata portion of the gain on the property would be recognized for federal income-tax purposes.

The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases. Contact your tax attorney or other adviser before undertaking any tax-related transactions.

Dr. Blair is a nationally known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists maximize profitability, slash taxes, and protect assets. The newsletter ($149 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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