Tax Tip for August 2008
The Housing
Assistance Act of 2008
The Housing Assistance Tax Act of 2008, (“the
Housing Act”) was signed into law on July 30, 2008. The Housing Act consists of
tax breaks for homebuyers and homeowners. To offset these tax breaks, the
Housing Act also includes revenue raisers, the most important being the
reduction of the homesale exclusion. Below is a summary of the three main
provisions of the Housing Act: Credit for first-time homebuyers, Property tax
deduction for non-itemizers, and, Tightened homesale exclusion revenue raiser.
Credit for first-time homebuyers
The single largest provision in the Housing Act
is a measure allowing individuals buying their first home to take a tax credit
of up to $7,500 of the purchase price. Designed to help reduce the existing
stock of unoccupied housing, the tax credit allows qualified homebuyers to
subtract the credit amount from their federal income tax when they buy a home.
However, they are then required to pay the credit back over 15 years. The result
is that the credit resembles an interest-free loan that must be repaid to the
government. Here are the details of the new credit:
Individuals may credit the
lesser of $7,500 or 10% of the price paid for the home against tax owed in the
year of purchase. The $7,500 maximum credit applies both to individuals and
married couples filing a joint return. A married individual filing separately
can claim a maximum credit of $3,750.
The credit phases out for
individual taxpayers with modified adjusted gross income between $75,000 and
$95,000 ($150,000-$170,000 for joint filers) for the year of purchase.
In the second year after
purchase, taxpayers who took the credit must start adding the credit amount back
into taxes paid incrementally over 15 years with no interest charge. This would
work as follows. Suppose a first-time homebuyer purchases a home in December of
2008. He could claim a tax credit equal to 10 percent of the purchase price of
the home or $7,500, whichever is smaller, on his 2008 tax return. Assuming for
purposes of this example that the amount of his credit is $7,500, he then would
be required to pay $500 (one-fifteenth of the credit) back on his 2010 tax
return and on his return for each of the following 14 years.
If the taxpayer sells the home
(or the home ceases to be used as the principal residence of the taxpayer or the
taxpayer's spouse) prior to complete repayment of the credit, any remaining
credit repayment amount is due on the tax return for the year in which the home
is sold (or ceases to be used as the principal residence). However, the credit
repayment amount may not exceed the amount of gain from the sale of the
residence to an unrelated person. For this purpose, gain is determined by
reducing the basis of the residence by the amount of the credit to the extent
not previously recaptured. No amount is recaptured after the death of a
taxpayer. In the case of an involuntary conversion of the home, recapture is not
accelerated if a new principal residence is acquired within a two-year period.
In the case of a transfer of the residence to a spouse or to a former spouse
incident to divorce, the transferee spouse (and not the transferor spouse) will
be responsible for any future recapture.
The tax credit is refundable,
meaning that households with incomes too low to owe income taxes could benefit
from it.
The credit applies to homes
purchased on or after April 9, 2008 and on or before July 1, 2009. A special
rule allows those who purchase a principal residence after Dec. 31, 2008, and
before July 1, 2009, to treat the purchase as made on Dec. 31, 2008 (effectively
allowing them to claim the credit on their 2008 returns rather than on their
2009 returns).
A taxpayer is considered a
first-time homebuyer if the individual (and the individual's spouse if married)
had no ownership interest in a principal residence in the U.S. during the
3-year period prior to the purchase of the home to which the credit applies.
No credit is allowed if the
D.C. homebuyer credit is allowable for the taxable year the residence is
purchased or a prior tax year, the taxpayer's financing is from tax-exempt
mortgage revenue bonds, the taxpayer is a nonresident alien, the taxpayer
disposes of the residence (or it ceases to be a principal residence) before the
close of the tax year for which the credit otherwise would be allowable, or the
home is acquired from certain related persons or by gift or inheritance.
A home under construction by a taxpayer is
treated as purchased by him on the date he first occupies it. Therefore, anyone
contracting to have a residence constructed should fix a completion date that
will allow ample time to move in before July 1, 2009 in the event of unforeseen
delays. It may even be wise to add a penalty clause that will make up for loss
of the credit in the event construction delays prevent the buyer from moving in
before that date.
Property tax
deduction for non-itemizers in the 2008 Housing Act
The provision creates a new
standard deduction for state and local real property taxes paid by taxpayers who
claim the standard deduction rather than itemizing their deductions. Since most
homeowners who are paying on a mortgage have enough deductions (e.g., mortgage
interest and property taxes) to justify itemizing them on their return, this new
provision chiefly benefits homeowners who have paid off their homes.
The deduction is available only
for the 2008 tax year.
The amount of the deduction is
as much as $500 for single filers and $1,000 for joint filers.
Tightened
homesale exclusion revenue raiser
To pay for the $15.1 billion of housing tax
incentives, Congress passed several offsetting revenue raisers, including a
provision requiring homeowners to pay tax on gains made from the sale of a home
to reflect the portion of time the home was not used as a principal residence.
Most homeowners are aware of the homesale
exclusion, a provision of the tax law which provides that homeowners who sell
their principal residence typically don't need to pay taxes on as much as
$500,000 of their gain if they meet certain conditions. (The $500,000 exemption
is the maximum exclusion for a married couple filing jointly; taxpayers filing
individually get an exemption of up to $250,000.) To be eligible for the full
exclusion, a taxpayer must have owned the home—and lived in it as his or her
principal residence—for at least two of the five years prior to the sale.
Because of the “principal residence” requirement, vacation or second homes
normally don't qualify for the exclusion. However, in what some saw as a
loophole, the law permitted taxpayers to convert their second home to their
principal residence, live in it for two years, sell it, and take the full
$250,000/$500,000 exclusion available for principal residences, even though
portions of their gains were attributable to periods when the property was used
as a vacation or second home, not a principal residence.
The new law closes that loophole by requiring
homeowners to pay taxes on gains from sales of a home to reflect the portion of
time allocated to periods of “nonqualified use”.
Generally, nonqualified use is any period (other than the portion of any period
before Jan. 1, 2009) during which the property is not used as the principal
residence of the taxpayer or spouse. However, nonqualified use does not
include:
... any portion of the
5-year period which is after the last date that the property is used as the
principal residence of the taxpayer or spouse;
... any period (not to
exceed an aggregate period of 10 years) during which the taxpayer or spouse is
serving on qualified official extended duty; and
... any other period of temporary absence (not to
exceed an aggregate period of 2 years) due to change of employment, health
conditions, or other unforeseen circumstances specified by IRS.
The amount of gain
allocated to periods of nonqualified use is the amount of gain multiplied by a
fraction where the numerator is the aggregate periods of nonqualified use during
the period the property was owned by the taxpayer and the denominator of which
is the period the taxpayer owned the property.
In other words, the amount taxed will be based on
the portion of the time during which the taxpayer owned the home that the house
was used as a vacation home or rented out. The rest of the gain remains eligible
for the up-to-$500,000 exclusion, as long as the two-out-of-five year usage and
ownership tests are met. The new law in effect reduces the exclusion based on
the ratio of years of use as a principal residence to the total time of
ownership.
Illustration: A married couple bought a vacation
home on January 1, 2009 and owned it for ten years, including living in it as a
principal residence for two years prior to selling for a $500,000 gain. Under
old pre-Act law, since the couple lived in the home as a principal residence for
2 of the 5 years prior to sale, they could use their full $500,000 homesale
exclusion and the entire gain would be tax-free. Under the Housing Act, the
maximum available exclusion would be reduced by four-fifths as the nonqualified
use period (i.e vacation home) was eight out of the ten years the home was
owned. Accordingly, the $500,000 full exclusion under pre-Act law would be
reduced by four-fifths, to $100,000 under the Housing Act. Therefore, $400,000
would be subject to tax under new law.
The good news for current owners of second homes
is that the new law is not retroactive. The tightening applies only to sales
after 2008. Plus, any periods of nonqualified use before 2009 are ignored for
purposes of the provision. Also, the new law doesn't change the rule that
allows homeowners to take advantage of the homesale exclusion every two years.
Taxpayers can still “home hop” with full tax exclusion if they only own one home
at a time. Moreover, the taxpayer still qualifies for capital gain treatment on
the amount of gain that cannot be excluded.
