Tax Benefit to Aid First-Time Homebuyers

February 9th, 2009

Now may be a good time to purchase a home as a lot of good deals are awaiting those with a down payment to facilitate a purchase.  If you are a first-time homebuyer, you can benefit from a limited-time tax break designed to help first-time homebuyers afford the down payment on a home.

For home purchases made after April 8, 2008 and before July 1, 2009, a first-time homebuyer (the definition is very liberal) can receive a refundable tax credit equal to 10% of the purchase price of the home, but capped at $7,500 ($3,750 for married taxpayers filing separately).

Here are the details of this novel first-time homebuyer credit.  Keep in mind, however, this credit is only available for a limited time. 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 they owe no tax or the credit is more than the tax that they owe.

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, must be repaid.  You should 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 she (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the 3-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his or her 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 you make an eligible purchase in 2008, you claim the first-time homebuyer credit on your 2008 tax return. For an eligible purchase in 2009, you can choose to claim the credit on either your 2008 (or amended 2008 return) or 2009 return.

Homes that Qualify – Only the purchase of a main home located in the U.S. qualifies.  Vacation homes and rental properties are not eligible. You must buy the home after April 8, 2008, and before July 1, 2009. For a home that is to be constructed, the purchase date is the first date that 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 a taxpayer’s 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 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.  No credit is allowed for married joint filers with MAGI of $170,000 or more and for other taxpayers with MAGI of $95,000 or more. If your MAGI falls within the phase-out range, a partial credit will be allowed.

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.

• The home is no longer used as the main home.

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

• The taxpayer is a nonresident alien.

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

• The 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 you properly claim a $7,500 first-time homebuyer credit on your 2008 return, you will begin paying it back on your 2010 tax return. Normally, $500 will be due each year from 2010 to 2024.

You may need to adjust your withholding or make quarterly estimated tax payments to ensure you are not under-withheld.

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

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

• Ceases Being the Main Home – If the home is no longer used 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 the 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, you purchase a home for $200,000 and claim the credit of $7,500.  Assume that you make no improvements on the home and sell it for $195,000 after repaying $500 of the credit.  You would measure your gain or loss 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, you would have a gain of $2,000 on the sale ($195,000 – $193,000).   Thus, you would be liable for repaying only $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, no repayment would be required.

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

• Involuntary Conversion – If the home is involuntarily converted (e.g., it is 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.

In addition to the credit, the tax law also allows first-time homebuyers to make a penalty-free withdrawal of up to $10,000 from their IRAs for the purchase of a home.  Married couples can each withdraw up to $10,000 from their separate IRA accounts for this purpose.  Although the withdrawal is penalty-free, it is still taxable so you should consider carefully the tax ramifications and the impact on your future retirement before invading your IRA accounts.

It is probably appropriate to consult with this office in advance of a home purchase where you or family members are contemplating on utilizing the new credit or withdrawing from an IRA.

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