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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2008

The Other Side of the Tax Credit

People are extolling the new first-time-homebuyer tax credit, but is it too good to be true?

The U.S. housing market continues to show signs of downturn. Many economists say this will continue until 2009 or 2010.

In response, Congress recently passed legislation to try to strengthen the housing and mortgage industries and provide them stability, support and resources while the market continues toward recovery. In July, President George W. Bush signed this legislation -- the Housing and Economic Recovery Act of 2008 -- into law.

The new housing bill has many parts. One that is expected to have a particular impact on mortgage brokers and lenders, as well as homebuyers, is an Internal Revenue Service (IRS) first-time-homebuyer tax credit.

Mortgage brokers would be wise to understand what the tax credit entails, as well as its positive and negative aspects. With this knowledge, you can best help your clients determine if this tax credit -- praised by many in the industry -- is too good to be true.

What are the essentials?

The new housing bill implements a temporary first-time-homebuyer tax credit for the purchase of a principal home. This includes detached single-family homes, attached townhomes and condominiums. The definition even covers a principal home for taxpayers who own secondary or vacation homes but who are presently renting their principal residence.

The tax credit is capped at 10 percent of the purchase price to as much as $7,500; most first-time homebuyers will receive the full credit. For purchase transactions less than $75,000, the credit is 10 percent of the purchase price.

The new law defines a first-time homebuyer as someone who has not owned a principal residence during a three-year period before purchase. For married taxpayers, if either spouse has owned a principal home in the past three years, the IRS will disallow the credit. Also, homeownership traditionally is defined as being “in title” or being a party on the deed on a principal home.

Further, the date of purchase is critical. To qualify for the tax credit, a home purchase -- or the date of the closing -- must occur between this past April 9 and this coming July 1.

In addition, the tax credit is refundable. Taxpayers can claim the credit with or without income to offset. For first-time homebuyers, the tax credit will either offset existing tax liability in the taxable year, or a tax-refund check will be mailed to them.

Brokers and their clients must keep in mind that this is not a cash credit at closing like lenders and brokers may be used to seeing on settlement statements. First-time homebuyers must claim the credit on their tax returns.

Lost in the accolades of this credit is the fact that it works like a zero-interest “step” loan. First-time homebuyers must repay it in full to the government, without interest, over a 15-year period or when they sell the home, provided that equity remains after the sale. If there is no equity remaining after the sale, the government will absorb the deficiency.

Repayment starts two years after buyers claim the credit. Assuming the full tax-credit amount of $7,500 is claimed, this will result in a $500 per annum payment to the IRS for 15 years.

The new law also states that if the house is sold before the end of the 15-year period, the seller will be taxed on the lesser of:

  1. The gain from the sale if sold to an unrelated party; or
  2. The unrecaptured balance of the credit.

The recapture amount cannot exceed the full amount of the credit.

There are income qualifications, as well. To qualify for the full tax credit, single taxpayers must have modified adjusted gross incomes (M.A.G.I.) of as much as $75,000, and married couples’ income cannot exceed $150,000. Incomes greater than these limits may result in partial tax-credit availability. But taxpayers with M.A.G.I. amounts greater than $95,000 for single buyers and $170,000 for married buyers who file their taxes jointly will not receive a tax credit.

In addition, the tax credit’s application to new-home construction depends on who performed the construction work. If the homeowners constructed the home, then the purchase date is the first day they occupy the home. In this situation, the date of the first occupancy must be between this past April 9 and this coming July 1.

If a construction company or another builder constructed the home, the closing date will determine when clients can claim the tax credit.

What are the downsides?

There are some reasons the tax credit might not be the cure-all to stimulate the economy and assist first-time homebuyers. You should know this additional information to dispense thorough mortgage advice to your clients.

  • Repayment: As stated previously, the credit must be repaid. For a full tax credit of $7,500, that amount equals $500 per year. This is an effective monthly payment of about $42.
  • Mortgage-revenue bonds (MRBs): The IRS will disallow the credit if the taxpayer’s financing derives from tax-exempt MRBs. This means that homebuyers cannot claim the tax credit if they are using financing from a state- or local-housing-agency first-time-homebuyer program. This may be the most significant reason the tax credit could be a results-neutral solution to meeting the objective of assisting first-time homebuyers while providing an economic stimulant to the housing and mortgage industry.

Many states already have low-interest-rate loan programs in place, financed through MRBs, to assist first-time homebuyers. These programs have different names in differing jurisdictions, but they all essentially have the same objective: to tailor low-interest mortgage-financing products to first-time homebuyers.

In South Dakota, for instance, this is called the “First-Time Homebuyer Program” and is administered by the South Dakota Housing Development Authority (SDHDA). State and local government housing-finance agencies such as the SDHDA sell MRBs on Wall Street and to investors. They use the proceeds to finance below-market-rate mortgages for qualifying first-time homebuyers. Income limits and purchase-price restrictions apply in varying amounts depending on the city and state.

There are other potential problem areas, as well. The IRS will disallow the credit if the first-time homebuyer sells the principal residence or if the residence loses its status as a principal home before the end of the tax year in which the credit is claimed. This will probably not affect many homebuyers, but it may be relevant if your clients know that a move or sale is imminent before the end of the credit year.

Nonresident aliens also cannot claim the credit, and the IRS will disallow the credit in Washington, D.C.

Summing it up

At the least, the tax-credit law is a well-meaning attempt to stimulate a stagnant housing market while providing an incentive for people to purchase a first home.

The repayment requirement will help reduce the anticipated $4.8 billion cost of this credit to taxpayers. Also, it is hoped that homebuyers and the economy in general will benefit from more-stabilized housing and mortgage markets as a result.

By ignoring the first-time-homeowner programs already in effect in some states and excluding those homeowners from claiming the IRS tax credit, however, the question will remain for some time as to the intermediate and long-term effects this legislation is intended to promulgate. By not considering the possibility that the federal tax credit and an MRB-financed loan could peacefully coexist, Congress may have inadvertently shut out many of the first-time homebuyers it was attempting to help.

Additionally, as there are differences in first-time-homebuyer programs in each state, savvy buyers should seek professional mortgage or real estate advice and should proceed cautiously to make an informed and wise investment decision when purchasing their first homes.

Note: None of the information in this article should be construed as legal advice. Seek advice from counsel, your accountant or your certified public accountant about the applicability of the Internal Revenue Service tax credit to your specific situation. Any legal statements in this article should be interpreted as general principles of law and are not necessarily applicable in your state or to your specific situation.


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