Questions Gather About Homebuyer Tax Credit
This tax season, there’s a lot to consider when it comes to claiming the credit available for first-time homebuyers and so-called long-term residents who purchase a new principal residence.
“It’s important to work with your CPA to sort through the complexities associated with the homebuyer credit. There are three versions to understand,” explains Bob Ranweiler, tax principal with LarsonAllen.
Summary of Homebuyer Tax Credit
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- In the Housing and Economic Recovery Act of 2008, Congress added a new refundable $7,500 tax credit for first-time homebuyers who acquired a U.S. principal residence after April 8, 2008.
- This first-time homebuyer credit was subsequently enhanced by Congress in early 2009, increasing the credit to $8,000.
- With the signing of the Worker, Homeownership, and Business Assistance Act of 2009 on November 6, 2009, Congress further modified the $8,000 first-time homebuyer credit and also made available a $6,500 homebuyer credit to certain existing homeowners (“long-term residents”) who purchase a new principal residence.
- The November 2009 modifications apply to purchases that occur after November 6, 2009 through April 30, 2010. That date is extended to June 30 for homebuyers who enter into a binding contract by April 30 and actually acquire the new home by June 30, 2010.
- In the case of a newly constructed home, a purchase is considered to occur on the date the taxpayer first occupies the residence.
- A one-year extension of these deadlines is added for overseas military and other government service workers.
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Who qualifies as a first-time homebuyer
Whether it is the earlier 2008 version or the improved 2009 one, the “first-time homebuyer” definition is a constant. To qualify, the individual must not have had an ownership interest in a principal residence during the three-year period ending on the date of purchase. For newlyweds who acquire their home when married, neither spouse may have owned a residence within the prior three years.
For single individuals who acquire a home under a split ownership arrangement, the IRS has issued very flexible guidance in IRS Notice 2009-12. Single individuals may allocate the first-time homebuyer credit in one of several ways, including based on their percentage ownership interest, their contribution toward the purchase price, or “any other reasonable method,” such as allocating the entire credit to one or the other. Under this IRS guidance, if two single individuals purchase a home prior to marriage and one is ineligible for the credit because of prior home ownership, the credit may be allocated entirely to the eligible purchaser.
Tax Tip
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Recognize that a “first-time homebuyer” is simply measured by a three-year look back from the date of purchase. Accordingly, as an example, a 75-year old retiree who has been renting for four years could now purchase a condo as his or her principal residence and receive the $8,000 first-time homebuyer tax credit.
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Who qualifies as a long-term resident
Long-term residents who acquire a different principal residence (not a vacation home) after November 6, 2009, are eligible for the new $6,500 tax credit. Long-term residents are those individuals who have owned and occupied the same principal residence for any consecutive five-year period of the preceding eight years. As in the case of first-time homebuyers, a married couple must each meet the ownership and occupancy tests to be eligible for the credit. The same rules described above under the first-time homebuyer credit also apply to single individuals who jointly acquire a new residence and wish to qualify for the long-term resident homebuyer credit.
Long-Term Resident Example
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Bill and Julie, a married couple, have resided in their present residence for the past seven years. On March 1, 2010, they close on the purchase of a new principal residence at a cost of $300,000. Assuming Bill and Julie meet the income eligibility test described below, they qualify for the $6,500 tax credit in their 2010 tax return, whether the cost of this home is more or less than their former residence, and whether the home is newly constructed or an existing home. If Bill and Julie were not married and only Julie qualified as a long-term resident, the $6,500 credit could be allocated entirely to her.
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How the homebuyer credits apply depending on the version
The following is a summary clarifying how these credits apply for 2008, 2009, and a portion of 2010.
2008: $7,500 first-time homebuyer credit
For homes purchased from April 9, 2008 through December 31, 2008, the tax credit was 10 percent of the purchase price, limited to $7,500. If the credit exceeded tax, it produced a refund. But the 2008 version of the credit was automatically recaptured beginning in 2010 at the rate of $500 per year, in 15 subsequent tax returns. Effectively, this version of the credit represented an interest-free loan worth much less than its stated $7,500 value. Further, the 15-year payback is accelerated if both spouses leave the residence within the 15-year recapture period, with the payback eliminated only in the case of death or the destruction of the residence.
2009: $8,000 first-time homebuyer credit
An improved version of the credit applies for homes purchased from January 1, 2009 through April 30, 2010, (June 30 if the binding contract rule applies). The credit is again 10 percent of the purchase price, but the limit is modestly increased to $8,000. But more importantly, there is no automatic recapture. Assuming the taxpayer resides in the home for three years following the purchase, the entire $8,000 may be retained.
2009: $6,500 long-term resident homebuyer credit
Long-term residents who purchase a new principal residence after November 6, 2009, may qualify for a refundable tax credit equal to 10 percent of the purchase price, but it’s capped at $6,500. Like the 2009 first-time homebuyer credit, there is no automatic payback, and the taxpayer may retain the entire credit if he or she lives in the home for three years following the purchase.
Income eligibility
Both first-time and long-term resident homebuyers are subject to an eligibility rule based on income:
- The 2008 and 2009 credit phases out proportionately as tax return income, technically modified adjusted gross income (AGI), moves from $150,000 to $170,000 for joint filers. Similarly, single filers lose the new credit as their income moves from $75,000 to $95,000.
- For purchases made after November 6, 2009, single filers may qualify for the full credit if their income is under $125,000, and joint filers are eligible for the full credit until their income exceeds $225,000. The credit then phases out over a $20,000 income range above these thresholds.
Limitations on purchases after November 6, 2009
Congress has imposed stricter limitations on claiming the first-time homebuyer credit and the long-term resident credit for purchases made after November 6, 2009:
- No credit is allowable for homes that cost over $800,000.
- The homebuyer or spouse must be at least 18 years old on the purchase date to qualify for the credit.
- A buyer who can be claimed as a dependent on another taxpayer’s income tax return for the year of purchase cannot claim the credit.
- Prior rules disallowing the credit for homes purchased from certain related parties have been expanded. Now, homes may not be purchased from parties related to spouses of buyers (i.e., in-laws).
Additional documentation required for 2009 and 2010
The IRS is now requiring the following documents be attached to the 2009 and 2010 Form 1040 to verify the taxpayer’s eligibility for the first-time homebuyer credit or the long-term resident credit. As a result, these returns must be paper-filed and will require somewhat longer processing:
- The signed settlement statement or if a newly constructed home, the certificate of occupancy
- For long-term residents, evidence of five years of ownership (either Form 1098 mortgage interest statements, real estate tax statements, or homeowner insurance records for five consecutive years)
- The signed contract entered into on or before April 30, 2010, for those claiming the credit on a purchase closing in May or June of 2010
Election to claim in prior year
The law allows a taxpayer to electively treat the purchase as occurring in the prior tax year. Generally, this rule is used to secure the refund for the taxpayer one year earlier. For example, if someone purchases a qualifying residence in February of 2010, the credit can be claimed in the 2009 return to accelerate the refund.
Tax Tip
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To receive the first-time homebuyer rebate from the government promptly, a taxpayer purchasing a qualifying residence in 2010 will likely use the special election to claim the $8,000 tax credit in the 2009 Form 1040. However, if the credit is claimed in 2009, that year’s tax return income applies for the income eligibility test. In cases where the taxpayer’s income is higher in 2009 than 2010, it will be better to defer claiming the credit until the 2010 return is filed to avoid phase-out of the credit. Note that for homes acquired after November 6, 2009, the higher phase-out schedule applies.
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Recapture rule—avoid owing the government
Except for even more onerous rules associated with the 2008 version of the credit, there is a payback to the government if the taxpayer disposes of the home too soon. “The recapture rule is a cliff—sell after 35 months and you owe the full federal credit, but sell after 37 months, and you’ll owe nothing,” states Ranweiler.
Further, recapture applies if the taxpayer merely ceases to use the property as the principal residence (such as, conversion to business or rental use), even if a sale has not occurred.
There are only a few exceptions where recapture does not apply, including death, involuntary conversion, or a marital dissolution where one spouse remains in the home. There is also a gain limitation: the credit payback is limited to the gain on the sale but with the original credit treated as a basis reduction in the tax cost of the home.
How we can help
LarsonAllen’s tax team is available to assist you in sorting through all of the complexities associated with the homebuyer credit. We can also help determine in which year’s return the credit should be claimed to maximize your refund. For more information, contact a tax principal in your region.