§53511 Tax Treatment of Nonqualified Withdrawals

Summary

Money taken out of a capital construction fund that is not a qualified withdrawal is treated as a nonqualified withdrawal. Withdrawals come out in this order: ordinary income account first, then capital gain account, then the capital account. If taken from the ordinary income account, it is taxed as ordinary income in the year you take it. If taken from the capital gain account, it is taxed that year as a long‑term capital gain (for assets held more than 6 months). For the regular tax filing deadline for that year, no normal interest or late penalties apply, but interest on the extra tax tied to the ordinary income or capital gain parts is charged at a special rate set by Treasury based on a comparison to 8 percent; no interest is charged on amounts treated as withdrawn under the last‑in‑first‑out rule. If money stays in the fund many years, parts of it become nonqualified: 20% after the 26th taxable year, 40% after the 27th, 60% after the 28th, 80% after the 29th, and 100% after the 30th. Fund earnings count as deposits for this test. An amount is not treated as remaining if there is a binding contract at year end to spend it on a qualified item. If the fund is larger than needed, the excess can be treated as nonqualified unless the owner makes a plan within 3 years to use it. Amounts in the fund on January 1, 1987 are treated as deposited on that date. For tax math, a nonqualified withdrawal is left out of gross income but your tax is increased by the withdrawal amount times the highest tax rate (with a 20% cap—34% for corporations—on certain capital gain parts). If part of the withdrawal came from deposits that did not reduce your earlier tax, that part is handled instead as a deduction in the year you withdraw it.