The First-Time Homebuyer Credit has been extended so that it now expires on April 30, 2010 (September 30, 2010 closing for binding contracts in place by April 30, 2010). A reduced credit is also available for long-term homeowners who buy a new principal residence. The income phaseout thresholds have been raised. Requirements to claim the credit, including new documentation requirements, have been tightened up.

Congress extended the closing date from June 30, 2010 to September 30, 2010 in the Homebuyer Assistance and Improvement Act of 2010, H.R. 5623, which President Obama was scheduled to sign on July 2, 2010. Congress previously extended the expiration of the First-Time Homebuyers Credit in the Worker, Homeownership and Business Assistance Act of 2009 (WHBAA), enacted November 6, 2009.

The credit was originally created as part of the Housing Assistance Tax Act of 2008 (HATA), enacted on July 30, 2008 and effective for "first-time homebuyers" who purchase a principal residence after April 8, 2008 and before July 1, 2009.¹ Under the American Recovery and Reinvestment Act of 2009 (ARRA) passed earlier this year, the credit was extended to purchases before December 1, 2009. Now the expiration has been further extended to purchases before May 1, 2010, but the credit will also be available if a binding contract is in place before May 1, 2010 and the closing is done before October 1, 2010.

Under WHBAA, a special rule has been enacted for individuals on qualified extended military duty outside the United States. Individuals who serve on qualified official extended duty service outside the United States for at least 90 days during the period beginning after December 31, 2008 and ending before May 1, 2010 and their spouses are eligible for the first-time homebuyer’s credit for residence purchased during an additional year, up to purchases before May 1, 2011 or when a binding contract is in place before May 1, 2011 and the closing is done before July 1, 2011.

The purpose of the credit is to provide a tax incentive to help a sagging entry level housing market in the United States due to the collapse of the subprime mortgage industry.

"First-time homebuyers" are defined as individuals who haven’t owned a principal residence during the three years ending on the date of the purchase of the residence for which they are claiming a credit.

Under WHBAA, an individual and, if married, the individual’s spouse who have lived in a principal residence for a five-consecutive year period out of the previous eight years are considered "long-time residents" eligible for a reduced credit for residences purchased after November 6, 2009.

The residence must be a principal residence of a taxpayer that is located in the United States. Under WHBAA for a residence purchased after November 6, 2009, no credit is allowed if the purchase price of the residence exceeds $800,000. (Silicon Valley takes it in the shorts again!)

For 2008, the credit was ten percent of the purchase price of the residence to a maximum of $7,500, or $3,750 for a married person filing a separate income tax return. The maximum total credit for one residence for multiple buyers is $7,500. Since the credit had to be repaid over a fifteen-year period, it was actually an interest-free loan and not a permanent tax break.

For 2009, ARRA has increased the maximum credit to $8,000, or $4,000 for a married person filing a separate income tax return. (The credit is still ten percent of the purchase price to the maximum.) The fifteen-year payback period has been eliminated. The credit will now only be recaptured if the taxpayer sells the home or the taxpayer or taxpayer’s spouse ceases to use the home as a principal residence within 36 months after the purchase.

The maximum first-time homebuyer credit for long-time residents (previous homeowners – see the sixth paragraph, above) for a residence purchased after November 6, 2009 is $6,500 or $3,250 for a married person filing a separate return.

The IRS has given a lot of flexibility for allocating the credit when there are multiple buyers. For example, say parent Bob buys a home with his adult children Holly and Dawn. If Bob and Holly have so much income the credit would be phased out on their income tax returns, all of the credit can be allocated to Dawn. What if Bob and Dawn don’t live in the residence, so only Holly qualifies for the credit? All of the credit ($7,500 for 2008 or $8,000 for 2009) can be allocated to Holly (based on the total cost of the residence). The taxpayers can allocate the credit as they wish,² but changing ownership during the year of purchase can cause some problems because of the related party sale rules.

As a result of Notice 2009-12, there is a "marriage penalty" in the First-Time Homebuyer Credit. The maximum credit for a married person filing a separate return is one-half the total maximum amount, or $3,750 for 2008 and $4,000 for 2009. If an unmarried couple buy a home and one of them doesn’t qualify for the credit, the other partner can claim up to the $7,500 maximum credit for 2008 and $8,000 maximum credit for 2009. Here is another tax planning consideration for deciding when to get married!

If a taxpayer purchases a qualified residence during 2009, he or she may elect to treat the purchase as made during 2008 to get the refund sooner. The new limits will apply to the 2009 purchase. You can even amend the 2008 income tax return immediately after buying the home to claim the credit. However, the lower adjusted gross income threshold for 2008 (explained in the next paragraph) will still apply on the 2008 income tax return, because the acquisition date is considered to be December 31 of the calendar year preceding the purchase when computing the AGI limitation.

For residences purchased before November 7, 2009, the credit is phased out when modified adjusted gross income (AGI) exceeds $75,000 or $150,000 for married persons filing a joint return. The phase out is computed based on the ratio of the excess of modified AGI to $20,000. If a married couple has modified AGI of $170,000, the credit is zero.

Under WHBAA, the modified AGI thresholds have been increased for residences purchased after November 6, 2009 to $125,000 or $225,000 for married persons filing a joint return. If a married couple has modified AGI of $245,000, the credit is zero.

Modified AGI is AGI increased by any amount excluded from gross income under the foreign earned income and housing costs exclusion, U.S. possessions income exclusion, and Puerto Rico income exclusion.

A residence purchased from a related person will not qualify for the credit if the tax basis of the property is determined with reference to the tax basis of the seller (all or part of the transfer is a gift), or for inherited property if the tax basis is based on the date of death value or alternative valuation date value of the property (all or part of the transfer is an inheritance).

A residence built by the taxpayer will be considered purchased on the date the taxpayer first occupies the residence.

The credit is not allowed if:

• For 2008, the credit for first-time homebuyers in the District of Columbia was allowable to the taxpayer or the taxpayer’s spouse for the tax year of the home purchase or any prior tax year (no double dipping!). After 2008, the DC credit isn’t allowed if the first-time homebuyer credit is allowable to the taxpayer or the taxpayer’s spouse. (Only the first-time homebuyer credit is allowed after 2008.)
• For 2008, the purchased residence is financed using proceeds of a tax-exempt mortgage revenue bond (repealed for 2009);
• The taxpayer is a nonresident alien;
• Before the end of the tax year of the purchase, the taxpayer disposes of the residence or it ceases to be a qualified residence of the taxpayer (or, if married, the taxpayer’s spouse);
• Under WHBAA, effective for a residence purchased after November 6, 2009, an individual who is claimed by another individual as a dependent also isn’t eligible to claim the credit;
• Under WHBBA, effective for residences purchased after November 6, 2009, the taxpayer has not attained age 18; or
• Effective for tax years ending after November 6, 2009 (2009 and thereafter), a taxpayer who claims the New Homebuyer Tax Credit is required to attach a "properly executed copy of the settlement statement" to the tax return in order to claim the credit.

New IRS documentation requirements.

In response to perceived widespread abuses of taxpayers claiming the credit when in fact they didn’t qualify, the IRS is requiring that certain documents be attached to the income tax return in which the credit is claimed, starting in 2009. Since these documents are included with the federal income tax return, it can’t be e-filed.

As mandated by Congress, a copy of the settlement statement for the purchase of the home is required to be attached. This will usually be the HUD-1 settlement statement. The statement should show all parties’ (buyers and sellers) names and signatures. The property address, the contract sales price, and the date of purchase.

If the home is a mobile home for which there is no HUD-1, a copy of the retail sales contract, including signatures, should be attached.

When claiming the credit for a newly constructed home for which there is no executed settlement statement, a copy of the certificate of occupancy, showing the taxpayer’s name, property address and date of the certificate, should be attached.

Taxpayers claiming the $6,500 tax credit for long-term residents are required to document their residence for five consecutive years during the eight-year period ending on the purchase date of the new residence by attaching copies of one of the following for the five-year period: 1) Form 1098, Mortgage Interest Statement (or equivalent); 2) property tax statement; or 3) homeowner’s insurance statement. Some taxpayers might not have kept these records and might have to request them from a bank, county assessor or insurance company so they can include them with their income tax return.

If the documents aren’t received, the IRS will probably disallow the credit.

Recapture rules for 2008 purchases.

The homebuyer credit is repaid to the government as recapture ratably over 15 years, with no interest charge. The recapture is an increase to income tax liability of 1/15 of the credit amount per year during the recapture period. The recapture period is the 15-year period beginning with the second year after the tax year when the residence was purchased.

In case of later separate returns or a divorce, half of any credit allowed on a joint return is treated as having been allowed to each spouse.

If the taxpayer sells the home or ceases to use the home as a principal residence before the end of the recapture period, any portion of the credit that hasn’t yet been repaid to the U.S. government must be added to the tax for that year. However, the credit recapture is limited to the amount of gain for the sale of the residence to an unrelated person. For this purpose, the tax basis of the home is reduced by the amount of the unrecaptured credit. If the taxpayer has a loss from the sale of the home, no recapture is due.

Here are exceptions to the recapture rules:

• If the taxpayer dies before the credit is repaid, the balance of the unrecaptured credit is forgiven.
• If there is an involuntary or compulsory conversion (condemnation) of the home, the recapture isn’t accelerated, provided the taxpayer acquires a new principal residence within two years of the date the taxpayer disposes of the home or ceases to use it as a principal residence. The taxpayer continues to repay the credit according to the original schedule.
• If the residence is transferred to a spouse or former spouse incident to a divorce, the recapture is not accelerated. The spouse who receives the residence becomes responsible for making the recapture payments according to the original schedule.
• Under WHBAA, effective for dispositions after December 31, 2008, certain members of the armed forces who dispose of their principal residence in connection with government orders received by the individual or the individual’s spouse for qualified official extended duty service, the recapture is waived. The exception applies to a member of the uniformed services, a member of the U.S. Foreign Service or an employee of the intelligence community.

For 2008 purchases, if a taxpayer decides to use a tax return preparer because he or she has this credit, the benefits will be reduced by the tax return preparation costs over the term from claiming the credit through repaying it. For example, John received a $7,500 New Homebuyer’s Credit for 2008. In the past, he prepared his own income tax return. He decided to use a preparer to avoid forgetting to repay the credit. Say he paid $500 per year for the preparer. 15 X $500 = $7,500. John used his credit to pay his tax return preparer!

The IRS will issue a revised Form 5405 that reflects the extended deadline and higher credit. You will be able to get it at www.irs.gov.

Thanks to the changes during 2009, more individuals should be eligible for the First-Time Homebuyer Credit. The maximum cost of residence threshold will be a problem in some high-cost areas. The documentation requirements will be a headache for many taxpayers who keep poor records. The credit is much more attractive, especially for low to moderate income taxpayers.

For more articles and information about new tax real estate tax developments, visit our Real Estate Investor Tax Articles or Frequently Asked Questions and subscribe to our newsletter, Michael Gray, CPA's Real Estate Tax Letter.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this website was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

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1 IRC § 36 RETURN
2 Notice 2009-12, 2009-6 I.R.B .446 RETURN

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