The Housing and Economic Recovery Act of 2008 created a new first-time home buyer tax credit. The credit is not designed to help homeowners who bought or owned a home in the last few years and lost it in foreclosure, but rather to boost home sales and reduce the unsold homes inventory resulting from foreclosure and otherwise stimulate the housing market.
A “first-time home buyer” is an individual (their spouse, if married, or other co-owners) who has had no ownership interest in a principal residence during the prior three-year period. A principal residence for purposes of the credit includes a house, condominium, houseboat, mobile home, or stock held by a tenant-shareholder in a cooperative housing corporation, but not vacation or second homes.
The credit is structured as a temporary refundable tax credit equal to the lesser of: (i) $7,500 ($3,750 for married individuals filing separately); or (ii) 10 percent of the purchase price, of a home for purchases of a U.S. principal residence made after April 8, 2008 and before July 1, 2009. The credit phases out for individuals with modified adjusted gross income (AGI) in excess of $75,000 up to $95,000 ($150,000 up to $170,000 for joint filers). Half of any credit allowed on a joint return is allocated to each spouse. Eligible homeowners closing in 2008 take the credit on their 2008 returns, but those closing in 2009 can elect to treat the purchase as having been made on December 31, 2008, by amending their 2008 return.
The credit operates more like an interest-free loan repayable over 15 years. It must generally be recaptured (repaid) interest-free over a 15 year period, starting two years after the home purchase date, by increasing the taxpayer’s federal income tax liability by 1/15th of the credit amount each year. Taxpayers should increase withholding or estimated tax payments.
Any remaining unpaid amount of the credit is due on the individual’s return for the year in which the residence is sold or no longer used as a principal residence, but not exceeding the gain (if any) on sale of the residence to an unrelated person (determined by reducing the basis by the credit amount not recaptured). The taxpayer must file an income tax return even if not otherwise required to file because they do not meet the gross income filing threshold. Any outstanding credit amount is not required to be recaptured if:
- the taxpayer dies;
- involuntary or compulsory conversion and the taxpayer acquires a new principal residence within two years;
- transfer to a spouse, or to a former spouse incident to a divorce. (the transferee steps into the transferor’s shoes for both the regular and accelerated recapture rules, and the transferor is no longer responsible for any recapture).
If the home is acquired from a related person, the taxpayer’s basis cannot be determined by reference to the transferor’s adjusted basis. The taxpayer’s property basis cannot be stepped up to the fair market value (or special use value) on the date of death or alternate valuation date, if applicable, if the transferor was a decedent.
States generally do not incorporate federal tax credits, but recapture provisions may create a different basis in the property, and thus a different gain or loss upon sale for federal and state income tax purposes.