First Time Home Buyer Tax Credit

The Purpose of First Time Home Buyer Tax Credit

For a long time, people in the US preferred being a homeowner rather than a tenant. The belief that home prices always appreciate, made buying a home a good investment and fueled home prices. Adjustable rate mortgages (ARM) started becoming popular among the sub-prime borrowers and lenders. Borrowers, whose credit scores were poor, easily qualified for the 2/28 ARM. The low fixed rate of interest on the 2/28 ARM, for a two year period, was a great opportunity for the sub-prime borrowers to own a home and later encash the built up equity on the house. At the end of 2 years when the interest rates rose sharply, the homeowner would refinance the house or sell the house at inflated prices, pay off the mortgage and make a tidy profit. The sub-prime lenders and borrowers thrived as long as as real estate valuations increased home prices to a level that could no longer be sustained by the economy. In a span of less than 10 years, home prices appreciated by almost 124%. In the middle of 2006, home prices peaked and then started declining. The bubble burst resulting in a crash in the housing market. Declining home prices resulted in a number of people being unable to make mortgage payments. Refinancing the house was no longer an option since falling home prices meant negative home equity. Falling home prices made the erstwhile profitable investment, a proverbial white elephant. The homeowner who could no longer afford the mortgage payments; sell off the house or refinance it started defaulting on the mortgage. Lack of demand coupled with oversupply caused a slump in the housing market throughout the US. The correction in the housing market prices contributed to recession or a decline in economic activity over a sustained period of time. The first time home buyer tax credit was introduced to help revive the housing market by encouraging people to invest, once again, in a home. Tax credits are an example of expansionary fiscal policy aimed at increasing government spending in order to boost the level of economic activity and counter recession.

How does the First Time Home Buyer Tax Credit Work?

Tax Credit for 2008 Home Purchase: According to the Housing and Economic Recovery Act of 2008, any first time home buyer who bought a home between April 8, 2008 and before July 1, 2009 can claim the minimum of 10% of the price of the property or $7500 as a fully refundable tax credit. The upper limit of $7500 is for both unmarried people and married couples filing jointly. In case the couple files tax returns independently, the maximum available tax credit is $3,750 per person. This tax credit functions like an interest-free loan, which has a repayment period of 15 years. In other words, a first time home buyer can avail a loan of $7500 and repay 1/15th of the principal, starting in 2010, over a period of 15 years as the total repayment on the borrowed sum. In order to qualify for this tax credit, the buyer needs to purchase a home that is meant for immediate occupation. Rental properties and vacation homes do not qualify for the tax credit. The date of purchase, in case of a home under construction, is the same as the date of occupation. A person who did not own a home, prior to 3 years from the date of purchase, qualifies as a first time home buyer. This tax credit is only available for people, whose modified adjusted gross income (MAGI) is less than or equal to $75,000. In case of married couples, the maximum MAGI should be $150,000. People who bought the home from a close relative; financed the purchase using tax exempt revenue bonds; are non-resident aliens or sold the home before the end of the year are not eligible to claim the first time home buyer tax credit. The buyer can apply for the first time home buyer tax credit using IRS Form 5405.

Tax Credit for 2009 Home Purchases: For the homes purchased in 2009, the amount of first time home buyer's tax credit has been increased to $8000 from $7500, by the American Recovery and Reinvestment Act of 2009, provided the purchase is made before December 1st, 2009. The maximum credit for married people filing independently has also been increased to $4000. The buyers have the option of claiming tax credit on 2008 tax returns, that are due on April 15, 2009 or claiming the credit on the 2009 tax return, due April 15, 2010. The biggest advantage for the home buyers, who purchase a home in 2009, is that the tax credit doesn't have to be returned unless the home is not used as a primary residence by the buyer for at least 3 years from the date of purchase. The tax credit for 2009 home purchases is thus more advantageous to the buyer as compared to the first time home buyer's tax credit for 2008 since the latter has to be repaid over 15 years.

The American Recovery and Reinvestment Act of 2009 has a number of provisions meant to stimulate the economy. Expanding the first time home buyer's tax credit is a part of the stimulus package meant to revive economic growth and tackle recession.