McCombs TODAY

By Kristina Zvinakis, lecturer in the McCombs School’s Department of Accounting

In these economic times, not everyone will be comfortable making the decision to buy a home. However, to the extent that a first-home purchase is under consideration, the tax code provides an extra incentive that might tip the scales in favor of a purchase this year.

The American Recovery and Reinvestment Act of 2009 (otherwise known as the stimulus package) includes a tax credit for first-time home buyers equal to 10 percent of the home’s purchase price, up to a maximum of an $8,000 credit.

The first-time home buyer credit was initially enacted in July of 2008, in order to stimulate the ailing housing market. As originally enacted, the maximum credit amount was $7,500. But there is an important difference between the 2009 credit and the originally enacted credit: the 2009 credit does not have to be repaid. The original “credit” was essentially an interest-free loan from the federal government, to be repaid by the taxpayer in equal installments, over fifteen years (beginning two years after the year in which the credit was claimed). The newly enacted credit, effective for home purchases on or after January 1, 2009, and before December 1, 2009, is a true tax credit; a dollar-for-dollar reduction of tax liability owed in 2009.

For purposes of the credit, the tax law defines a “first-time home buyer” as a buyer who has not owned a principal residence during the three-years prior to the purchase of the home. For taxpayers who are married, this three-year requirement must be satisfied by both individuals. If two or more unmarried taxpayers purchase a home together, the credit amount can be shared among them. This is true for couples living together in a romantic relationship as well as for family members, such as siblings or a parent and child. 

Because of income restrictions, the credit will not be available to all taxpayers. The credit phases out for single taxpayers with modified adjusted gross incomes between $75,000 and $95,000. For married taxpayers filing a joint return, the phase out occurs between $150,000 and $170,000. Adjusted gross income (AGI) is total income for a year less “above-the-line deductions” such as IRA contributions, student loan interest expense, and moving expenses, but before itemized deductions or personal exemptions are subtracted. Note that AGI includes most forms of income—wages, salaries, interest income, dividends, capital gains and other miscellaneous amounts. For purposes of the credit, modified adjusted gross income is determined by adding to AGI any foreign earned income and income earned in certain U.S. possessions.

As with all tax-law changes, a number of additional details must be considered in order to utilize the credit. The home purchase must close and title to the property must be transferred to the home owner by November 30, 2009. Thus, the credit is not available for anticipated purchases. The credit is also refundable. This means that the government will send taxpayers who are entitled to a credit greater than their 2009 tax liability a check for the portion of the credit that exceeds their tax liability. Finally, the home buyer must use the residence as a principal residence for at least three years. If the home buyer utilizes another property as a primary residence or sells the home before this three-year period expires, the taxpayer will have to repay the credit in that year.

As an example of how the credit works, assume that a married couple, with modified AGI of $140,000, purchased a $285,000 home in March of 2009. Though 10 percent of the purchase price is $28,500, the couple would be eligible for a maximum $8,000 credit, as prescribed by the tax code. Because their AGI is less than the phase-out threshold, the full $8,000 credit would be available to offset their 2009 tax liability. However, if the same couple had modified adjusted gross income of $165,000, a portion of the $8,000 credit would be phased out. The phase out is calculated by taking the excess $15,000 over the threshold ($150,000) and dividing by the phase-out range of $20,000 which, in this situation, yields 75 percent. As a result, the couple is allowed 25 percent of the $8,000 credit available to them, $2,000, in 2009.