Tax Credit to Aid First-Time Homebuyers

First-time homebuyers may wish to take advantage of a new tax credit included in the Housing and Economic Recovery Act of 2008.
Available for a limited time only, the credit:

• Applies to home purchases after April 8, 2008, and before July 1, 2009.

• Reduces a taxpayer's tax bill or increases his or her refund, dollar for dollar.

• Is fully refundable, meaning that the credit will be paid out to eligible taxpayers, even if no tax is owed or the credit is more than the tax that is owed.

However, the credit operates much like an interest-free loan, because it must be repaid over a 15-year period. So, for example, an eligible taxpayer who buys a home today and properly claims the maximum available credit of $7,500 on his or her 2008 federal income tax return must begin repaying the credit by including one-fifteenth of this amount, or $500, as an additional tax on his or her 2010 return.

CAUTION: Taxpayers are cautioned that this credit is a loan, and except under some special circumstances noted in this article, it must be repaid.  Do not take this credit if you will be unable to meet the repayment requirements in the future.  The repayment is subject to the same penalties and interest and collection procedures as any other income tax when not paid on time.  In addition, your withholding or estimated payments may need to be adjusted to avoid the underpayment penalty.

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period, even if they file as married taxpayers filing separately. Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

When to Claim the Credit - If an eligible purchase is made in 2008, the first-time homebuyer credit can be claimed on your 2008 tax return. For an eligible purchase in 2009, the credit can be claimed on either your 2008 (or amended 2008 return) or 2009 return.

Homes That Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible. The home must be purchased after April 8, 2008, and before July 1, 2009. For a home that is constructed, the purchase date is the first date the home is occupied.

Amount of the Credit - The credit is 10 percent of the purchase price of the home, with a maximum available credit of $7,500 for either a single taxpayer or a married couple filing jointly. The limit is $3,750 for a married person filing a separate return. Unmarried taxpayers who purchase a home together are eligible to share the credit under an as-yet-to-be announced formula to be determined by the IRS.  In most cases, the full credit will be available for homes costing $75,000 or more. Whatever the size of the credit a taxpayer receives, the credit must be repaid over a 15-year period.

Income Limits – The purpose of the credit is to assist lower-income individuals in acquiring their own home. Thus, the credit is reduced or eliminated for higher-income taxpayers. The credit is phased out based on the modified adjusted gross income (MAGI). MAGI is the adjusted gross income plus various amounts excluded from income-for example, certain foreign income. For a married couple filing a joint return, the phase-out range is $150,000 to $170,000. For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if the:

• Home is purchased from a close relative. This includes a spouse, parent, grandparent, child or grandchild.

• Home is no longer used as the main home.

• Home is sold before the end of the year in which it was purchased.

• Taxpayer is a nonresident alien.

• Taxpayer is, or was, eligible to claim the District of Columbia first-time homebuyer credit for any taxable year.

• Home financing comes from tax-exempt mortgage revenue bonds.

How and When is the Credit Repaid - The first-time homebuyer credit is similar to a 15-year interest-free loan. Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed. The repayment amount is included as an additional tax on the taxpayer's income tax return for that year. For example, if a $7,500 first-time homebuyer credit is properly claimed on the 2008 return, the taxpayer will begin paying it back on his or her 2010 tax return. Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that they are not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If a taxpayer dies, any remaining annual installments are not due. If a joint return was filed and the taxpayer passes away, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If a taxpayer stops using a home as the main home, all remaining annual installments become due on the return for the year that happens. This includes situations where the main home becomes a vacation home or is converted to business or rental property. There are special rules for involuntary conversions.  

• Home Sold - If a home is sold, all remaining annual installments become due on the return for the year of sale. The repayment is limited to the amount of gain on the sale, if the home is sold to an unrelated taxpayer. If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated. For example, a home is purchased for $200,000 and the credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).   Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce - If a home is transferred to a spouse, or, as part of a divorce settlement, to a former spouse, that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it's destroyed in a storm), and the taxpayer buys a new principal residence within a two-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence. 

It may be appropriate to consult with this office in advance of a home purchase where you or a family member are contemplating on utilizing this credit.