The United States government is providing an incentive for home buyers through a tax credit of up to $8,000 for first-time home buyers and $6,500 for “step up” home buyers. The tax credit is available for eligible purchasers who are in contract by April 30, 2010, and close by June 30, 2010.
The home buyer tax credit has a number of conditions and restrictions, though, so we have provided this thorough Overview to help you understand how it works.
This Overview is organized as follows:
- Eligibility requirements for both first-time home buyers and “step-up” buyers.
- Income limitations.
- Personal eligibility requirements for home buyers.
- Property eligibility requirements for types of homes.
- Deadlines for getting into contract and closing.
- Specific requirements for buying with a spouse or partner.
- Exceptions for members of the armed forces or certain government employees.
- Tax filing issues.
- An explanation of how a tax credit works.
Obviously, this Overview is not intended to provide accounting or legal advice, and we urge you to speak with your accountant and attorney before making any final decisions on purchasing a property.
Requirements for First-Time Home Buyers and “Step-Up” Home Buyers
Unlike the first-time home buyer tax credit that was available for much of 2008 and 2009, the new home buyer tax credit is available to both first-time home buyers and “step-up” buyers (i.e., “long-time homeowners”). The tax credit for first-time home buyers is 10% of the purchase price, up to $8,000. The tax credit for long-time homeowners is 10% of the purchase price, up to $6,500.
To qualify for the first-time home buyer tax credit, you cannot have lived in a principal residence that you owned within three years of closing on your new home. So if you owned a home that you lived in within the past three years, you will not be eligible. But if you owned investment property that you did not live in during the past three years, you would still qualify as a first-time home buyer.
To qualify for the “step up” home buyer tax credit, you must have lived in the principal residence that you owned for at least five consecutive years out of the last eight. So if you have owned a home that you lived in for the past three or four years only, you will not be eligible. But if you have owned a home that you lived in for five consecutive years, and then rented it out for the last two, you would qualify as a “step-up” buyer. Although the law uses the term “step-up” buyer, it does not require that you “step up” in value in purchasing your new home, which is why we try to use the term “long-time homeowner” to more precisely define the tax credit. So you can get the tax credit even if your new home costs less than the home you own and currently reside in. Moreover, the law does not require that you sell your current residence, so if you otherwise qualify you could purchase a new home, live in it while you rent out your current property, and earn the $6,500 step-up buyer tax credit.
In order to obtain the tax credit, you have to qualify as either a first-time home buyer or a long-time homeowner. You cannot “mix” the qualification requirements. It’s one or the other.
The home buyer tax credit is only available to purchasers at certain income levels: yearly incomes of $125,000 for single taxpayers or $225,000 for married couples filing jointly. The tax credit starts to phase out above those levels, with partial tax credits available for taxpayers whose income is within $20,000 of the limits. The income level limits are the same for both the first-time home buyer tax credit and the longtime homeowner tax credit, so if your income is above those levels, you will not be eligible for either credit.
The partial tax credit is computed based on the amount of income you earn within the $20,000 phase-out range. For example, if your income is $135,000 for a single taxpayer, you would have $5,000 of income in that phase-out range (i.e., $5,000 above the $125,000 limit). That would “use up” 25% of the $20,000 phase-out range, so your partial tax credit would be the remaining 75%. So if you were otherwise eligible for the first-time home buyer tax credit of $8,000, your tax credit would be $6,000 (75% of $8,000).
The qualifying income levels are based on your “modified adjusted gross income” (“MAGI”), which includes your wages, salary, interest income, dividends, capital gains, and certain foreign investment income. Your MAGI is determined after making certain “above the line” deductions such as health savings account deductions, alimony, and others, but before the “itemized deductions” such as charitable contributions, state and local taxes, and home interest. Determining your qualifying income can be a complicated issue, so you should consult with your accountant before making any decisions.
Once we get beyond the income limitations, the rest of the personal requirements are fairly simple. You have to be a United States citizen (or legal resident aliens and permanent residents), you have to be 18 years or older, and you cannot be a dependent on someone else’s tax return. The purpose of these requirements is to prevent “sham” transactions that took place in early versions of the tax credit, in which parents were buying homes in the names of their underage dependent children to claim the tax credit. Similarly, you cannot get the tax credit if you do not actually purchase the property, but obtain it through inheritance or gift.
The law also requires that you intend to live in the home as your personal residence. Although the government has no way of reading your mind for your intentions, the law requires that you must pay the credit back if you move out or sell the home within three years of closing.
The home buyer tax credit is available for almost all property types that home buyers might purchase, including single-family homes, condominiums, cooperative apartments, and multi-family homes. The credit is even available for “personal property” types that people use as residences, including houseboats, trailers, and certain mobile homes if they are affixed to the ground.
The only restrictions on the property are simple. The property has to be priced at $800,000 or below, must to be located in the United States, and it cannot be currently owned by someone to whom you are directly related. So you will not qualify if you are buying a home from your parent, grandparent, great-grandparent, child, grandchild, great-grandchild, or your spouse’s family. The government wants to prevent “sham” transactions in which a father might sell a home to an adult child and enable the child to obtain the tax credit.
In order to claim either the first-time home buyer or long-time homeowner tax credit, you have to be in contract on your purchase by April 30, 2010 and close by June 30, 2010. These are hard deadlines, so be careful to make sure you get your contracts signed and your closing completed on time. We expect that we will see a rush of buyers hurrying to meet both deadlines, so be prepared to avoid last-minute complications that might delay contract signings or closings.
You can claim the tax credit even if you were already in contract at the time that the law was passed on November 6, 2009. The law does not require you to be in contract after a certain date, only that you are in contract by April 30, 2010. So buyers who got into contract, say, in the summer of 2009 without thinking they were getting a tax credit would receive the credit if they are otherwise eligible.
For people who are buying new construction, the same deadlines apply: you have to be in contract by April 30, 2010 and closed by June 30, 2010. But if you are building your own home, you have to be moved in by June 30, 2010, which generally means getting a certificate of occupancy by that time.
Buying with a Spouse or a Partner
The home buyer tax credit is available for people buying on their own, buying with a spouse, or buying with an unmarried partner such as a significant other or a family member. If you are buying on your own, the rules are relatively straightforward – you need to qualify under all the relevant criteria, including income restrictions. If you are buying with someone else, though, the rules can be a little complicated.
For married couples, both spouses need to qualify for the tax credit in their own right. Thus, if the couple files separate tax returns, both spouses need to qualify under the income restrictions or the couple will be ineligible for the tax return. For example, if the couple files separate returns and the husband makes $70,000 but the wife makes $150,000, the couple would be ineligible because the wife’s income would exceed the limits. Even though their income is below the $225,000 joint taxpayer limitation, the fact that they file singly and one of the spouses is above the income limitation would render them both ineligible. Similarly, if the husband owned his primary residence before the couple got married, but the wife never owned before, the couple would be ineligible: he would be ineligible for the first-time home buyer tax credit and she would be ineligible for the long-time homeowner tax credit.
For two unmarried people buying the home together, either partner can get a full tax credit if he or she qualifies, even if the other does not. So if an unmarried couple is buying a home together, and he qualifies as a first-time home buyer and she does not (either because of income or other eligibility requirements), he can get the full first-time home buyer tax credit even though she will get nothing. The same goes for unmarried partners buying a home, such as a father buying with a child: so long as one of the two partners qualifies, the qualifying partner can get the full credit. If both partners qualify, they can share the credit in any reasonable way allowed under IRS guidelines.
Armed Forces Exceptions
Certain exceptions apply to people who are members of the uniformed services of the United States military, members of the Foreign Service, or employees in the intelligence community. If you are a member of one of those services and will be on “Official Extended Duty” for at least 90 days between December 31, 2008 and May 1, 2010, you have an extra year to get into contract and close on your qualifying purchase. So if you qualify for this exception, you don’t need to get into contract until April 30, 2011, and you don’t need to close until June 30, 2011.
Moreover, those qualifying military or government personnel are exempt from the requirement that they need to live in the home continuously for at least three years after purchase, if they are assigned to a period of extended duty for at least 90 days at least 50 miles away from the home they purchased.
Tax Filing Issues
You can claim the tax credit either for the year of your purchase, or the year prior. So if you purchase a home in 2010, you can claim the tax credit on your 2009 return. That will be relatively easy if you close before the April 15, 2010 federal tax return filing deadline, but even if you close after April 15, 2010 you can request a filing extension or file an amended return after the filing deadline. You can also claim the tax credit for your 2010 purchase on your 2010 return for April 15, 2011.
In order to claim the tax credit, you will have to fill out IRS Form 5405 to determine your tax credit amount and eligibility, and then apply the credit on line 67 of your 1040 federal tax return. You will need to provide proof of your purchase, through your HUD-1 statement, in order to prove your eligibility.
How the Tax Credit Works
The home buyer tax credit is an enormous incentive for people who are thinking of buying a house in 2010. A tax credit is a dollar-for-dollar reduction in your federal tax obligations. For example, if you qualify for the full first-time home buyer tax credit and at the end of the year you owe $15,000 in federal taxes, the $8,000 tax credit will offset your burden and reduce your taxes to $7,000. And if you don’t owe federal taxes at all, you will get a rebate check from the government for $8,000.
Note that this tax credit is different from a tax deduction, particularly the home interest tax deduction familiar to home owners and most home buyers. People who own their own homes are allowed to deduct both the interest on their mortgage and their home property taxes, and both deductions provide tremendous benefits for homeowners. But a tax deduction is simply a reduction in your taxable income, not a dollar-for-dollar credit on your taxes.
For example, a homeowner who pays $20,000 in mortgage interest every year and another $10,000 in property taxes can deduct that $30,000 from her yearly income to reduce her tax obligations. So if she has $120,000 in otherwise taxable income, her taxable income would go down to $90,000. If she was paying, say, a 40% tax rate on that income, the $30,000 reduction in her taxable income would save her $12,000 in taxes (i.e., 40% of the $30,000 that would otherwise be taxed). The interest and taxes come off her income, reducing her taxable income and reducing her taxes.
But the home buyer tax credit is a straight dollar-for-dollar reduction in her taxes. If her taxes are $20,000, the full first-time home buyer tax credit of $8,000 reduces that tax burden to $12,000. Think of it this way: most people have to earn about $14,000 in income to make $8,000 in their pocket (after taxes). So the first-time home buyer tax credit is the equivalent of a $14,000 raise in your salary.
Similarly, another way to think about it is as a reduction in the price of the property you are purchasing. Say you are buying a $265,000 home, and are eligible for the full $8,000 first time home buyer tax credit. That $8,000 amounts to a 3% reduction in the price of the home.
Again, you should always consult with your attorney and accountant before you make a purchase intending to claim the home buyer tax credit. If you have any questions about this Overview, or we can help you in any other way, feel free to contact us.
The Bremner Group at Coldwell Banker
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