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Tax Incentives for Home Buyers in New Legislation

by Jerry Tuttle, CPA

Our Federal government is expert at closing the barn door after the livestock escape. In another example of that reactive approach to our problems Congress passed and the President signed the Housing and Economic Recovery Act of 2008. It is an attempt to mitigate the economic disaster created by their failure to strengthen regulatory control over the excesses in the lending markets at a time when that regulation was needed. The irony of bills like this is that they are a far more expensive way of solving problems than thoughtful common sense regulation put in place beforehand. My opinions aside this bill has a number of tax related provisions of which you need to be aware. The provision with the most impact for real estate professionals is the “first time homebuyer tax credit”.

First time homebuyers may qualify for a temporary refundable credit equal to the lesser of 10% of the purchase price of the home or $7,500 ($3750 for a married individual filing separately). This bill defines a “first time homebuyer” as a taxpayer who has had no ownership interest in a principal residence during the three year period immediately preceding the purchase of the new home. Oddly enough ownership of a vacation home is not a disqualifier as long as that vacation home has not been the taxpayers’ primary residence. Purchase date is escrow closing date or occupancy date for self built homes. Purchases from related parties do not qualify. This credit is available only for homes purchased between April 9, 2008 and July 1, 2009.

The credit is subject to an income test. Married couples with modified adjusted gross income (AGI) of $150,000 or less qualify for the full credit. Married couples with an AGI over $170,000 do not qualify. Married couples with an AGI between $150,000 and $170,000 have a reduced credit. For example an AGI of $160,000 would be allowed a credit of no more that $3,750. Single taxpayers have AGI limits that are one-half of the married limit ($75,000 is the single taxpayer AGI limit for the full credit).

The really unique part of this law is that the credit must be repaid in equal installments over a 15 year period. No interest is charged making this, in effect, an interest free loan. Repayments are to be in equal installments beginning two years after the credit is claimed. A taxpayer who purchases a qualifying home in 2008 and claims a $7,500 credit will begin repaying the credit in 2010 at $500 per year. Repayment will be accelerated if the taxpayer stops using the home as a principal residence or if the home is sold. The unrepaid balance will be due with the tax return filed for the year of sale. If the accelerated repayment is the result of a sale, the repayment is limited to the gain on the sale of the residence. If this is to apply the sale must be to an unrelated party. Basis is also to be reduced by the amount of unrecaptured credit. For example, a house was purchased for $200,000 and sold two years later for a price net of commissions and closing costs of $200,000. If the taxpayer received a credit of $7,500 and none of that credit had been repaid then the basis in the house is reduced to $192,500 and the full amount of the credit will need to be repaid in the year of sale. That is going to give a few taxpayers a little unwanted surprise when that happens.

One other way out of repayment of the credit is death. In that case no repayment is required. Taxpayers will need to maintain proper records to document tax basis if they claim the credit. Improvement costs become part of basis and documentation will be required if those improvement costs are going to be used to avoid repaying the credit amount.

The next important change for homeowners put in place by this law will cause some heartburn for those who think converting a rental property to a personal residence is a good way of avoiding capital gains tax. A little background will help. We all know (or should) that gains on the sale of a principal residence are excluded from taxation up to a maximum amount of $500,000 for a married couple and $250,000 for a single person. To qualify the house must have been used as a primary residence for two of the last five years. Some smart taxpayers have turned a rental property into a personal residence, lived in the residence for two years and then sold the residence using the exclusion to avoid capital gains on sale. That will no longer be a good option. This law change requires that any gain on the sale of a house not used solely as a primary residence be prorated between use as a primary residence and other usage. Any gain not allocated to use as a primary residence is taxable. For example, if you owned a house for five years and used it as a rental for the first three years and as a primary residence for the last two years any gain on sale would be allocated between the rental period and the primary residence period. In this case, 60% of the gain (three years as a rental divided by five total ownership years) is subject to tax. The law is, however generous with the phase in of this provision. It applies only to sales after December 31, 2008 and only non-qualifying usage that begins on or after January 1, 2009 is considered when the portion of gain subject to tax is calculated.

Another provision in the Act allows taxpayers’ unable to itemize and using the standard deduction to deduct payments for state and local property taxes. Not wanting to be too generous, the Act limits the deduction to the lesser of $1,000 ($500 for a single person) or the amount of tax paid. The deduction is only applicable to the 2008 tax year. This is not a deduction from adjusted gross income but rather an addition to the standard deduction amount.

The Act contains a number of other provisions intended to shore up the general economy and specifically the housing market and the lending that supports it. It includes increases in low income housing credits, simplifying the rules for tax-exempt housing bonds, expansion of the mortgage revenue bond program to permit refinancing of existing subprime loans, real estate investment trust reforms and other changes. The important tax point to note is that you have a short window of time to make the most of these changes.

About Jerry Tuttle

Jerry Tuttle, CPA

480-998-2755, ext.117
jerry@httcpa.com

Hammond, Travers & Tuttle P.C.

This page was last modified on October 03, 2008.

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