Unfortunately, when you make a withdrawal from your IRA it will be included as income on that year’s tax return. However, we had a couple ideas that might be helpful. First, are you eligible for a VA loan? Here’s a link to the eligibility rules. If you are eligible you could make the purchase with no down payment. While this would likely result in a higher monthly mortgage payment, you could use small distributions from your IRA to supplement your income. Since IRA withdrawals represent additional income, taking out a small amount over a number of years would likely be loss costly from a tax standpoint than making a major withdrawal.
Second, it might be possible to spread out your withdrawal from the IRA over two years. For example, if you closed the home sale in early 2012 you could take part of the downpayment from your IRA in both 2011 and 2012; this might help reduce the tax impact. We hope the VA loan is an option.