I have received a lot of calls about the IRS $7,500 First-Time Buyer Tax Credit which was included in the Housing and Recovery Act of 2008. I am sending this message in order to both clarify and alert you to a piece of legislation which could well save you thousands of dollars. I am excited for buyers who are eligible for this credit and first-time buyers should be excited too!
The credit applies to first-time buyer home purchases of a principle residence between April 9, 2008 and July 1, 2009. It is a tax credit and not a tax deduction. A tax credit is a reduction in income taxes owed! In other words, when a buyer files their income taxes for the year the home was purchased (2008 or 2009), they may be able to subtract $7,500 from the amount of federal income tax liability which will either increase their tax refund or reduce the amount of tax still owed.
Of note though is that this tax credit is not free. It has to be paid back. Repayment begins two years after the credit is claimed and must be repaid within 15 years. That´s $500 per year. Yes, it would have been much better if there was no repayment provision, but an interest-free loan for 15 years is not such a bad thing. That´s right -- there is no interest on the tax credit received.
While you might question the benefit of this type of tax credit, which requires repayment, let's take a look at a couple of examples wherein the benefits a $7,500 income tax credit could provide some very substantial financial help:
-- More first-time buyers than not have little left in savings after the purchase of the home. As new homeowners, they are now confronted with a mortgage payment that exceeds what they were accustomed to paying in rent. Plus, they may have a home to furnish, spend money on painting, some redecorating, carpeting and window coverings, & possibly the expense of making repairs or improvements. Many times these purchases are made with a charge card with interest rates upwards of 17%. Having the benefit of the $7,500 tax credit and repaying it over 15 years without interest could be a partial answer.
-- Now, instead of being short of cash after closing, let´s look at a situation where a buyer does have cash reserves after closing and is financially prepared for the purchase of the various items mentioned above. Why would a $7,500 tax credit be beneficial to them? Let´s assume a $300,000 mortgage was needed in the home purchase at 6.5% interest for 30 years. What if the $7,500 tax credit refund was used to pre-pay the mortgage? Using simple math that would be an annual interest savings of $487.50 which is just about equal to the $500 per year repayment obligation. Here, the savings is much greater than the simple math calculation. Pre-paying the mortgage by $7,500 will not reduce the monthly mortgage payment of a fixed rate mortgage because the payment remains the same, however, the real benefit is this: The outstanding mortgage balance is reduced by $7,500 and each future mortgage payment results in savings in mortgage interest and increased principal mortgage reduction. With each monthly mortgage payment more money goes to reducing the mortgage balance and less is applied to interest. Together these savings will exceed the $500 cost of repayment of the tax credit. The benefit over the term of the mortgage in interest savings and mortgage reduction will be quite surprising.
OK, so much for the examples. What if the home is sold prior to repayment of the tax credit? Another provision requires repayment of the balance of the tax credit owed in the event of a sale of the home prior to full repayment. However, special provisions do provide for circumstances where the balance owed is greater than the gain in value or when there is a loss in value. If the gain on the sale is less than the amount owed, part of the balance owed will be forgiven. If there was no gain, or even a loss, then the remaining balance would not need to be repaid.
Here are a couple of FAQs FYI:
Am I eligible? First time homebuyers who purchase a principle residence between April 9, 2008 and July 1, 2009 are eligible. If you (and your spouse, if married) have not owned your principle residence for a 3-year period before your purchase and you have never taken advantage of first-time homebuyer credit previously, you qualify as a first-time homebuyer.
How does it work? Like all tax credits, it will directly reduce the total amount of taxes you owe. When you file your taxes for the year you purchased your home (2008 or 2009), you will be able to subtract the amount of the credit from your federal income tax liability, increasing the size of your refund or reducing the amount you owe. For example, you file your ?normal´ tax return and find that you owe $2,000 in taxes. With this credit, your tax liability could be lowered by $7,500, which means, you instead get a $5,500 tax REFUND check from IRS.
How big is the tax credit? The tax credit is equal to 10% of the purchase price of your home up to $7,500. The full credit is available for single individuals whose adjusted gross income is less than $75,000. If your adjusted gross income is greater than $75,000 and your home purchase qualifies you for the full credit, the credit phases out according to the dollar amount (or percentage if less than $7,500). For married couples filing jointly, the credit begins to phase out at an adjusted gross income of $150,000.
What about repayment? The tax credit is not completely free money for you to keep. It has a payback provision that makes it similar to an interest free loan. Two years after the credit is claimed, you must begin repayment so that you will have paid the credit back in full over the course of 15 years. For those qualifying for the full credit, the payback amount is $500 per year. For those getting less than the full credit, you pay equally over the 15 years (which is a rate of 6.67% per year). If a qualifying home is resold before the credit is repaid, the seller will have to immediately pay the outstanding balance of the credit. If the home is sold at a loss, then you owe nothing back.
Note: Just recently, I have heard of a "push" amongst House and Senate leaders to restructure the credit and possibly delete the requirement for repayment. Keep tuned to the news as if this provision becomes law, it would make the credit much more valuable.Is there a way to get any cash flow benefits before I file my tax return?Any first time buyer who believes they would be eligible for all or part of the credit may wish to modify their income tax withholding thru their employer(s) by completing an IRS form W-4. In many cases, payroll withholding will decrease and take home pay will increase.
Bottom Line. Combined with favorable interest rates, a wide selection of homes for sale and more affordable home prices, this tax credit may be just the financial assistance many first time buyers need to move forward to purchase a home now.
