First-time Homebuyer Credit: Read the Fine Print First

As part of the American Recovery and Reinvestment Act of 2009, eligible first-time homebuyers can get up to $8,000 from the government in the form of a refundable tax credit, and can even expect the cash to arrive quickly (within 10 days of filing) with certain "strategizing." But, as with most tax-related legislation, this credit is laden with qualification requirements that must be followed before any checks will be mailed out.

Note: A "refundable tax credit" means a taxpayer can claim the credit even if he
or she has little or no income tax liability to offset. For example, say you owed $3,000
in federal taxes on your 2008 return, but you qualify for the maximum first-time
homebuyer credit, you would pay the government nothing AND you would get a
check for $5,000. Even better, if you were due to get a refund of $2,000, for example,
and qualify for the maximum first-time homebuyer credit, now you would get a check
for $10,000.

ELIGIBILITY

First-time homebuyers are taxpayers who have not owned a principal residence during the three-year period before the purchase date. This means you may be eligible even if you owned a home many years earlier. For married couples, both spouses must fit the definition of a first-time homebuyer. On the other hand, in the context of joint purchases among unmarried people, not every buyer must be a first-time homebuyer. For example, John and Jane (who are not married to each other) want to purchase a home together. John currently owns his own home, and Jane has always been a renter. In this instance, Jane is considered a first-time homebuyer but John is not. When it comes time to claim the credit, assuming all other eligibility requirements are met, Jane simply applies the entire credit on her return only.

Qualifying homes that can be purchased are expansive in type. Virtually all residences—single family, townhome, condominium, mobile home, even a house boat—fall under the purview of this legislation, so long as you use it as a principle residence. Even new construction is included.

Purchase means any acquisition, except one from a person related to you (such as your parents or your grandparents), and except if you inherited the property or it was otherwise gifted to you.

DOLLAR AMOUNTS

While $8,000 is the maximum possible credit, every taxpayer will not necessarily qualify to claim that full amount. The amount of credit that can be claimed depends on two things:

1. the purchase price of the property; and
2. the taxpayer's income.

In general, you can claim 10 percent of the purchase price of the property, up to $8,000. This means, if you purchase a property for $70,000, the maximum credit you may claim, assuming all other eligibility requirements are met, is $7,000. Any purchase price of $80,000 or above, assuming all other eligibility requirements are met (see below), will yield an $8,000 credit.

Note: Allocating the allowable credit may get tricky when multiple purchasers
are involved. If you are married and filing separately, and both you and your spouse

are first-time homebuyers, you can each claim half the credit on your individual
return; this is the only allocation method allowed. But, if two eligible, unmarried,
individuals purchase a home together, they may allocate the credit between them
using "any reasonable method," which may include 100 percent to one
individual. TIP: it would be wise for the parties to execute an agreement confirming
their agreed allocation at the time of closing so the issue is resolved between them.
As discussed above, if only one purchaser is eligible, he or she may be allocated
100 percent of the credit.

Even assuming a purchase price of $80,000 or more, you may not be eligible for the full credit, or any of the credit for that matter, if your income exceeds certain thresholds. This is known as "phasing out." The portion of the credit you may claim based on your income is determined as follows:

1. Full credit: If your "modified adjusted gross income" (MAGI) is less than $75,000,
or $150,000 if married filing jointly, you may claim the full amount of credit
available based on your purchase price.

Note: MAGI is determined by first looking at "adjusted gross income" (AGI). AGI
is total income for the year (e.g., wages, salaries, interest income, dividends
and capital gains), minus certain deductions (known as "above-the-line
deductions"). This first calculation is made based on values before itemized
deductions from Schedule A (or personal exemptions) are subtracted. Next,
certain amounts are added to AGI to arrive at MAGI (e.g., foreign income,
foreign-housing deductions, student-loan deductions, IRA-contribution
deductions, and deductions for higher-education costs).

2. Partial credit: If your MAGI is more than $75,000, or $150,000 if married filing
jointly, but less than $95,000, or $170,000 if married filing jointly, you may only
claim a portion of the credit available based on your purchase price. The
calculations for determining the value of the partial credit are based on a specific
formula issued by the Internal Revenue Service (IRS).

3. No credit: If your MAGI exceeds $95,000, or $170,000 if married filing jointly, you
cannot claim any credit, regardless of the purchase price of your property.

TIMING – WHEN YOU MUST PURCHASE

In order to claim the credit, you must purchase (and by purchase, the IRS means actually close the transaction) between January 1, 2009 and December 1, 2009.

Note: Under the previously enacted Housing and Economic Recovery Act of 2008,
taxpayers who purchased (i.e., closed on) a home on or after April 8, 2008 may
qualify for a maximum $7,500 credit (with the same additional eligibility
requirements discussed above). However, this credit acts more as an interest-free
loan, rather than an actual credit, because it must be repaid over 15 years (in 15
equal installments). Nonetheless, the possible $7,500 "credit" remains available to
qualifying purchases made in 2008.

STRATEGIZING – WHEN TO CLAIM THE CREDIT

The credit can be claimed on either your 2008 or 2009 federal tax return. But, one option may be more beneficial than the other, depending on your situation.

For example, income levels may change from 2008 to 2009, perhaps due to loss in investment income or unexpected loss of employment. Taxpayers who expect lower income in 2009 may actually qualify for a higher credit on their 2009 return due to the "phase out" provisions. Therefore, it would make more sense to wait to make the claim in order to maximize the benefits.

For taxpayers who can fully maximize the credit on 2008 returns, there are further filing strategies:

1. If you already filed your 2008 return: Once you make an eligible purchase, you
can file an amended return or refund form, rather than wait until next year. TIP: file
Form 1045 for a refund on taxes paid rather than an amended return. This form
accelerates refunds for individuals so that they can receive the cash more
quickly. Plus, the IRS has added operations to ensure timely processing, given the
expected influx.

2. If you filed an extension for your 2008 return: You have until October 15, 2009 to
file and claim your credit, rather than waiting until next year. If you file electronically,
you can still receive a refund within 10 days by direct deposit.

For Federal Housing Administration (FHA) loans, it is possible to immediately apply the tax credit toward a down payment. The U.S. Department of Housing and Urban Development (HUD) issued on May 29, 2009 Mortgagee Letter 2009-15, which provides guidelines as to such use of the tax credit. FHA's approved lenders will be permitted to "monetize" the tax credit through short-term bridge loans. Alternatively, the lender may "purchase" the tax credit from the borrower. The lender may deduct attendant costs, not to exceed 2.5 percent of the credit amount, from the "purchase price." This will allow eligible buyers to access the funds at the closing table. A significant limitation is that borrowers cannot use the credit toward the minimum 3.5 percent down payment required for FHA-insured mortgages. Rather, the credit can be used as an additional down payment, or towards other closing costs. This could, however, help achieve a lower interest rate for the borrower.

A NOTABLE CAVEAT

Unlike the previous first-time homebuyer legislation for 2008 purchases, this credit does NOT have to be repaid—UNLESS—you stop using the property as your principal residence within 36 months of your purchase. This includes situations where you sell the home, convert it to business or rental property, or the home is destroyed or condemned. You repay the credit by including it as additional tax on the return for the year the home ceases to be your principal residence.

STATE AND LOCAL CONSIDERATIONS

Many jurisdictions at the state and local level have adopted their own first-time homebuyer credit. You should inquire as to whether you qualify for additional benefits at these legislative levels.

For example, as of May 12, 2009, the State of Georgia enacted legislation granting its own version of a first-time homebuyer credit to residents of up to $1,800, payable over three years, for purchases closed before December 31, 2009.

Cook County, Illinois, on the other hand, provides the American Dream Down Payment Initiative Program (ADDI). Under ADDI, eligible first-time homebuyers are given cash to meet closing costs and a down payment in the form of an interest-free, five-year, forgivable loan. The loan would be a second lien on the purchased property, held by Cook County. Twenty percent of the loan will be forgiven each year for the five following years. However, eligibility for ADDI is even more limited than the federal tax credit. Most significantly, the applicant's income must be 80 percent or less of the median income for the area. Therefore, only low-income taxpayers will qualify.