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$8,000 Tax Credit for First Time Homebuyers

Introduction

On February 17, 2009, President Obama signed into effect the American Restoration and Recovery Act ("ARRA", the "Act", or commonly referred to as the "Stimulus Package"). Under the ARRA, the federal government will spend approximately $787 billion dollars on various government initiatives!

A portion of the $787 billion dollars will assist first-time homebuyers in buying their first home with up to $8,000 as a tax credit. In particular, Section 1006(b)(1) of the ARRA provides first-time homebuyers the opportunity to receive the greater of $8,000 or 10% of the purchase price of a primary residence in the form of a tax credit. First-time homebuyers must complete the purchase contract of the home by April 30, 2010, close on the purchase by June 30, 2010, and meet other requirements.

So, what the catch? None, really...the government wants people to buy homes to help stimulate the economy. Therefore, if you're thinking about purchasing a new home, it behooves you to take a look at how the tax credit can assist you in becoming a new homeowner.

In this article, we’ll explore: what is a tax credit; the requirements to qualify as a first-time homebuyer for the ARRA tax credit; show how the ARRA tax credit works; and provide additional resources for first-time homebuyers who may have a difficult time in obtaining the necessary financing for the tax credit.

Next, we’ll explore what is a tax credit.

What is a Tax Credit?

Tax credits can come in different forms, but a true tax credit is a dollar-for-dollar reduction in what a taxpayer owes on his or her tax return. The ARRA tax credit is a true tax credit which offers homebuyers 10% or up to $8,000 of the purchase price of a primary residence.

This means the federal government will pay a first-time homebuyer money if he or she owes less in taxes to the IRS than the tax credit for the 2009 tax year. This is also called a refundable tax credit because the federal government will refund the first-time homebuyer up to $8,000 on his or her 2010 income tax return. It is the equivalent of receiving free money for purchasing a new home as a first-time homebuyer.

Also, do not confuse tax credits with tax deductions! Tax credits and tax deductions are very different. Tax deductions act to reduce a taxpayer’s tax burden, but not as much as a tax credit. The IRS subtracts a tax deduction as a percentage from the amount of income that is taxed, while a tax credit acts as a dollar-for-dollar reduction in what a taxpayer owes.

Let’s go over a few examples to clarify:

Scenario 1: You sign a contract for the purchase of your new home for $100,000 between January 1 and April 30, 2010 and qualify for the first-time homebuyer ARRA tax credit. Under this scenario you will receive 10% of the purchase price or up to $8,000. Ten percent of $100,000 equals $10,000. Therefore, you will receive $8,000 because you can only receive up to $8,000 with the ARRA tax credit. The $8,000 will be credited to you dollar-for-dollar when you file your 2010 income tax return. For example, if you owe $2,000 on your 2009 income taxes, you will receive $6,000 ($8,000 tax credit - $2,000). If the government owes you money for your 2009 income taxes, you will receive what the government owes you plus the $8,000 tax credit.

Scenario 2: Same facts as above, but you purchase a $70,000 house. Here, you would only receive $7,000 as a tax credit (i.e. because 10% of $70,000 is $7,000). But remember, the $7,000 will be credited to you dollar-for-dollar when you file your 2010 income tax return. So, as you can see, any homes with a purchase price of $80,000 or more will qualify for the full $8,000 tax credit, while homes with a purchase price below $80,000 will only receive 10% of the purchase price.

NOT Part of ARRA (just used to clarify distinction between tax credits and tax deductions):

Scenario 3: Same facts as Scenario 1, but instead you receive a tax deduction instead of a tax credit. Here, we would also need to know your adjusted gross income (i.e. AGI) to determine your tax bracket. For example, if you made $50,000 in gross income in 2009, and your adjusted gross income was $40,000 you would fall into the 25% federal tax bracket. Here, 25% of $8,000 is $2,000. Therefore, your taxes would be reduced by $2,000; not $8,000 like the tax credit. You can clearly see that a tax credit goes much further than a tax deduction. Tax credits credit a taxpayer dollar-for-dollar while tax deductions only reduce a percentage of taxpayer’s tax.

Don’t worry about Scenario 3 for purposes of the ARRA. We included Scenario 3 simply to show the difference between a tax credit and tax deduction.

Next, let’s explore if you meet the requirements to qualify for the tax credit.

Requirements to Qualify for ARRA Tax Credit

As previously stated, the ARRA provides first-time homebuyers of a principal residence the opportunity to receive 10% of the purchase price or up to $8,000 in the form of a tax credit. So, what are the requirements to qualify for this great deal?

The general requirements to qualify for the tax credit include:

Requirement 1: Complete purchase contract for primary residence between January 1, 2009 and Arpil 30, 2009. In other words, the buyer and seller must both sign a completed contract for the purchase of the residence by April 30, 2010.

Requirement 2: Closing on the residence must occur by June 30, 2010. In other words, if you complete a contract to purchase a home before April 30, 2010, but do not close the deal until after June 30, 2010, you do not qualify for the tax credit. It is therefore important to become pre-approved to purchase your home, and take care of all of the other requirements in purchasing a home to meet the two deadlines.

Requirement 3: Live in Principal Residence for 3 Years

The first time homebuyer must live in the residence for at least 3 years and claim the residence as his or her primary residence. In other words, first-time homebuyers cannot purchase the property as solely an investment property. Further, if you move before the end of 3 years, the IRS will require you to pay back the tax credit.

Requirement 4: You Cannot Have Owned a Home for the Past 3 Years

In order to qualify as a "first-time homebuyer," you must have not owned a home for the past 3 years. Additionally, if you are married and purchase the home, both you and your spouse must have not owned a home for the past 3 years. In other words, the IRS looks at both spouses independently of each other for purposes of the tax credit. However, with unmarried joint purchasers only one person must not have owned a home for the past 3 years.

Requirement 5: Fall Within the Maximum Income Limits

Depending on how much money you make per year, and whether you file as a single taxpayer or jointly as a married couple, you may only receive a reduced tax credit or none at all. To qualify for the full tax credit, first-time homebuyers must make less than $75,000 for singles or $150,000 for couples. However, higher-income buyers may receive a partial credit.

In particular, a single taxpayer who earns an adjusted gross income (i.e. AGI) between $75,000 and $95,000 will only receive a partial tax credit. Single taxpayers who earn $95,000 or more in adjusted gross income do not qualify for any tax credit.

Married taxpayers filing a joint return who earn a combined AGI between $150,000 and $170,000 will only receive a reduced portion of the tax credit. Married taxpayers who earn $170,000 or more in AGI do not qualify for any tax credit.

So, how does the partial tax credit work? Well, the partial tax credit phases out the tax credit proportionately. For example, if you earn $85,000 as a single taxpayer and meet all the other requirements for the tax credit, you’ll receive a $4,000 tax credit. This is because you fall right in the middle of the $75,000 to $95,000 income cap limits and would therefore only receive half of the tax credit (i.e. $4,000).

Requirement 6: Claim the Tax Credit on Your 2010 Income Tax Return

This step is the easiest. We’ll go over this in the next section.

Next, we go over how to claim the tax credit on your 2010 income tax return.

How to Claim the Tax Credit

Applying for the credit is simple. You simply need to claim the tax credit on your 2010 income tax return. No other special forms or papers need to be filed.

In particular, first-time homebuyers should complete IRS Form 5405 to determine their tax credit amount. Then, first-time homebuyers should claim that amount on Line 69 of their 1040 income tax return. No other applications or special forms are required. However, you will want to be sure that you qualify for the credit under the income limits and first-time homebuyer (please read previous page for income limits)

Note: You cannot claim the credit on Form 5405 for an intended purchase for some future date. You must actually have completed the purchase.

Further, states are assisting homebuyers in obtaining the tax credit. For example, some states are willing to help out first-time homebuyers by with loans specifically for the tax credit. Essentially, the state will lend the homebuyer a certain amount of money to make the purchase and receive the tax credit. Then, when the homebuyer receives the tax credit on his or her 2010 tax refund, the state will collect the tax credit back from the homebuyer in some type of repayment plan. These programs help first-time homebuyers get enough money to make the down payment and receive the tax credit.

As of the time of this writing, state tax credit loan programs that can help out include: Colorado, Delaware, Idaho, Kentucky, Missouri, New Jersey, Ohio, Pennsylvania and Tennessee.

Please refer to the National Council of State Housing Agencies’ website or your state for further updates and details.

Finally, on to the conclusion.

Conclusion

The tax credit will certainly bring additional new homeowners into the market. According to an estimate by the National Association of Realtors, approximately 300,000 new homebuyers will enter the market due in part because of the tax credit.

In essence, a new homebuyer may look at the tax credit as a discount on the home price. For example, a $100,000 purchase on a new home effectively becomes a $92,000 purchase. So, if you are a first-time homebuyer make sure to see if you qualify for the ARRA tax credit, and make sure to act by the appropriate deadlines.