The First-Time Homebuyer Tax Credit: A Primer

Transcription

1 The First-Time Homebuyer Tax Credit: A Primer Special Studies, November 4, 2008 By Robert D. Dietz, Ph.D. Report available to the public as a courtesy of HousingEconomics.com The Housing and Economic Recovery Act of 2008 (H.R. 3221), enacted into law on July 30th, 2008, established a number of new programs intended to stimulate the housing market. One of these provisions is the temporary first-time homebuyer tax credit. The tax credit provides an incentive for new homebuyers to enter the housing market, thereby reducing housing inventories and taking some of the downward pressure off house prices. Many observers believe that the current economic crisis, the first symptoms of which appeared in the housing market, can only end when house prices stabilize.[1] A similar credit was enacted in 1975 to reduce an excess overhang of newly-constructed homes. The first-time home buyer credit requires no separate application but is claimed on the taxpayer s usual tax return.[2] The tax credit must be repaid to the IRS over a period of up to 17 years. Thus, in economic terms, the tax credit is actually a zero-interest loan. As a zero-interest loan this tax incentive has a real economic value (approximately $4,200). No tax lien will exist on the buyer s home because of the repayment; repayment simply affects future tax returns. The credit was designed to have the biggest bang for the buck with a limited budget, hampered by Congressional PAYGO rules requiring budget neutrality on tax legislation. Given that Congress insisted on limiting the cost of the credit to the Treasury to $4.9 billion, the repayment provision was a necessary component - despite that it limits the positive economic impacts of the credit. Nonetheless, consumer interest in the credit appears to be present. NAHB s website on the tax credit has been visited by more than 470,000 unique visitors since it was launched with the signing of the legislation.[3] First-Time Homebuyers For the purposes of the tax credit program, a first-time home buyer is defined as an individual who has not owned a principal residence (as defined by Section 121 of the Internal Revenue Code) for at least three years prior to the date of purchase of the home. Note that this definition of a principal residence includes house boats, mobile homes (house trailers), and duplexes for both determining the types of homes that qualify for the credit, as well as the determination of who is a first-time home buyer. Also, it is important to note that ownership of a rental home or a vacation home that is not used as a principal residence does not disqualify the home buyer from the tax credit program. For married taxpayers, both spouses must qualify as first-time home buyers to claim the

2 credit. It is currently not clear whether non-married joint purchasers (perhaps a couple buying a home prior to marriage) must both qualify as first-time buyers or how the credit is allocated between the buyers if they qualify.[4] Credit Amount The credit is equal to 10% of the qualified purchase price of a principal residence, up to a maximum of $7,500. Thus, for homes purchased at a price of $75,000 or more, the credit amount is equal to $7,500. According to previous NAHB research, the median first-time home buyer can be expected to purchase a home with a price of approximately $150,000.[5] The tax credit is also refundable, which means that the full value of the credit can be claimed even if the home buyer has limited tax liability. NAHB research has reported that the median first-time home buyer has an income of approximately $64,000.[6] Using IRS data, we can approximate from this estimate of income (as opposed to taxable income) that the median first-time home buyer has a final tax liability of only about $5,000. If a family with this tax liability made a home purchase of a $150,000 home and qualified for the $7,500 credit, then their refund would depend on their income tax withholding. Suppose that the family had $4,000 withheld for income taxes during the year. This means, absent the tax credit, the family would owe the IRS $1,000 at tax filing. However, with the home buyer tax credit, the family would in fact receive a check of $6,500 ($7,500 minus the $1,000 owed) upon tax filing. Like other tax credits and deductions, the home buyer tax credit is subject to income phase-outs. Single taxpayers reporting modified adjusted gross incomes (MAGI) of $75,000 or less can claim the full credit amount.[7] For married taxpayers, the applicable phase-out amount is $150,000. The phase-out range is $20,000 above $75,000/$150,000, above which no credit may be claimed. For MAGI amounts in the phase-out range, the credit claimed is proportional to amount of MAGI above the phase-out amount relative to $20,000. For example, for a single taxpayer with a MAGI of $85,000, who otherwise would claim a $7,500 credit, the taxpayer is $10,000 above the phase-out amount, which means the taxpayer loses 50% of their credit ($10,000 divided by $20,000) yielding a final credit amount of $3,750. Timing The credit is available for purchases on or after April 9, 2008 and before July 1, 2009.[8] The reason for this retroactive qualifying period (the credit became law on July 30, 2008) is that the Congress wanted to be sure that prospective home buyers did not put off a purchase while Congress deliberated the legislation. Qualified home purchases in 2008 are claimed on a buyer s 2008 tax return, typically filed in early However, the law also allows 2009 purchases to be claimed on the 2008 tax return, if the buyers elects. This rule allows purchases in early 2009 (presumably before April 15th) to be claimed on the 2008 tax return or the 2009 tax return. Further, purchases after April 15th but before July 1, 2009 can be claimed on the 2008 or 2009 tax return. This means that home buyers can claim the credit on an amended 2008 tax return filed after April 15th. The benefit of claiming the credit on the 2008 return is that doing so accelerates when the full benefit of the credit is received by the home buyer from the IRS.

3 Credit Available at Closing Because a first-time home buyer does not realize the benefit of the credit until filing a tax return, the credit does not provide immediate assistance at the time of closing. This is a limitation for all tax incentives, which almost by definition must be claimed after the action they are intended to promote has occurred. Techniques for turning the tax credit into funds that can be used immediately at the closing table are called monetizing the credit. There are at least two potential options for monetizing the tax credit. One at the time of this writing conflicts with certain housing finance rules. The other allows for partial monetization. The first option would allow certain financial institutions to advance the credit amount as a short-term loan with repayment due upon tax filing. The advanced amount could then be used for the purpose of a downpayment. However, these loans are currently not permitted as sources of downpayment by Fannie Mae, Freddie Mac, and the Federal Housing Administration under existing guidelines.[9] The second option is for home buyers who are certain they qualify for the credit to reduce their income tax withholding.[10] This option allows buyers to increase their takehome pay and help accumulate a downpayment. Of course, buyers need to be cautious about this option because if they do not qualify for the credit, they could face significant interest and penalties for under withholding their income taxes. A third option would be for the credit to be transferred from the buyer to the seller in exchange for cash that could only be used as a downpayment on equity in the home. This option would require a legislative change to the tax code, however. Repayment of the Credit The law requires taxpayers to begin repaying the tax credit two tax years after the credit is initially claimed. For most taxpayers, who will claim the credit on their 2008 tax return, this repayment will begin when they file their 2010 tax return in early The repayment period is 15 years, hence taxpayers will repay the credit 6.67% per year (or about $500 per year for taxpayers claiming the full $7,500 amount). This repayment will occur on their tax return and will not require additional filing. Taxpayers anticipating this repayment can increase their income tax withholding at work by $42 per month. There is an exception to this repayment rule. If the taxpayer ceases to use the home as a principal residence, then the outstanding tax credit amount (the amount not repaid) is due when filing that year s taxes. For example, if a home buyer purchases a qualified principal residence in 2009, claims the $7,500 credit on their 2008 tax return, and sells the home in 2012, then the remaining amount ($6,500, which is net of repayments in 2010 and 2011) is due on the 2012 tax return. However, this acceleration of the repayment only occurs if there is sufficient capital gain generated from the sale to allow full repayment. For example, if the home is sold and no capital gain is generated (because the home has experienced sufficient price appreciation for example), then the remaining $6,500 described above is forgiven. In this regard, the tax credit is not only a zero-interest loan, but it is also one for which the government is assuming the price risk of the underlying investment. And as noted above, no tax lien exists again the home, so while the repayment functions economically as a loan, it is not a loan for legal purposes.

4 Value of the Credit The tax credit is economically equivalent to a loan with a zero interest rate. Clearly, any zero-interest loan has a monetary value. The value is equal to saved interest from obtaining a similar loan at market interest rates. Using this method, the value of zero-interest self-amortizing loan equal to $7,500 relative to a similar loan with an interest rate of 7% is equal to $4,200 in nominal terms. The table below demonstrates this calculation. Thus, the credit offers a real value for home buyers, particularly for first-time home buyers who likely face multiple expenses as a part of a home purchase, including moving expenses, home improvement, and furniture purchases. To the extent that these represent a single bundle of expenses that must be financed for the home purchase to be feasible under the potential buyer s budget constraint, the tax credit encourages a home purchase. Combining with Other Housing Tax Incentives The tax credit cannot be claimed by home buyers utilizing the proceeds of a tax-exempt Mortgage Revenue Bond (MRB) or the District of Columbia Home Buyer Tax Credit. In each of these cases, such a combination would violate the tax code s general principle against double-dipping (receiving multiple tax benefits for one transaction). The MRB program allows state housing agencies to issue tax-exempt debt to finance below market-rate mortgage for first-time home buyers. However, it remains unclear whether the first-time home buyer tax credit can be used in combination with the Mortgage Credit Certificate (MCC) program.[11] The MCC program allows issuance of tax credits to firsttime home buyers, rather than below market-rate mortgages, as under the MRB program. Nonetheless, home buyers can claim the tax credit and participate in Mortgage Revenue Bond programs when those programs are financed by taxable bonds.

5 Housing Market Impacts The need for a robust homebuyer tax credit is critical given the current economic conditions of the housing market and the financial system. The following figures present the levels of sales, inventory and months-supply for the new and existing homes markets using Census and National Association of Realtors data respectively.

6 While inventories are declining in the new home market since late 2007 due to decreases in builder production, the month-supply measure remains high at 10.4 as of September 2008 due to large declines in sales. In the existing home market, the increase in inventories due to increasing number of foreclosures is also keeping supplies of homes high. The intent of the tax credit is to attract first-time buyers to the market in order to increase home sales, reduce inventories, reduce pressure on housing prices, and establish a bottom for the housing market as a whole. Targeting first-time buyers is an effective method of achieving this economic policy goal. According to 2007 Census data, first-time buyers make up 39.6% of home buyers in a given year. The congressional estimate is consistent with approximately 2 million taxpayers claiming the credit. Thus, first-time buyers constitute a large percentage of the market. These buyers can also be more selective about the timing of obtaining homeownership and are this more price sensitive. Furthermore, stimulating purchases among first-time homebuyers can generate multiplier effects in the housing market. Presently, one of the chief difficulties facing existing homeowners is the challenge of selling their existing home in order to purchase a new home, whether it be a larger home due to family considerations or a home in a different location due to employment requirements. Stimulating sales among first-time homebuyers allows eases the ability of these existing homeowners to sell their home and purchase a new home. Nonetheless, given the current state of uncertainty in the financial system, home buyers expectations of continuing falling house prices, and worsening economic conditions, the

7 home buyer tax credit is not likely to have a significant impact in the short-run. This is due to the fact that it cannot be used to facilitate a purchase for first-time home buyers who do not have a sufficient downpayment, as well as the recapture requirements. However, a back-of-the-envelope estimate can be given of its expected impacts. The most straightforward method is to assume a measure of price-elasticity (total consumer price response) of negative one (standard for housing market analysis). The $7,500 credit is equal to 5% of the median first-time home buyer s house price. This suggests that home sales should increase 5% over the expected forecast due to the credit, absent recapture considerations. Factoring in the recapture element suggests using the $4,200 estimate found in this article as the monetary value of the credit, yielding a 2.8% increase in total sales. Using the NAHB sales forecast for 2009, this suggests that the home buyer tax credit as now established could increase home sales by approximately 143,000 over the baseline expectation of 5 million total home sales. This number could be higher given the scale of the multiplier effect, as existing homeowners sell their homes to a first-time buyer, which in turn facilitates the sale of a larger or newer home. The estimate presented here assumes comparable impacts for this effect, but it could be substantially larger given the scope or limitations of the credit. A word should be said about the timing of these impacts. NAHB survey data of builders have noted little if any impact of the tax credit on home sales. However, the tax credit program is only a few months old, as of this writing. Further, if home buyers anticipate falling housing prices and are accommodating to stricter downpayment and credit standards, then it is reasonable to expect that the bulk of tax credit induced sales will occur near the end of the program - the Spring of In ordinary times, 143,000 additional home sales would represent a considerable market impact, but these are not ordinary times. NAHB s 2008 projections show existing single family home sales down by 1.8 million, and single-family starts down over 60 percent from the peak in In such a depressed environment, even stronger policy tools are needed. These could include a mechanism to facilitate use of the credit for downpayment purposes, as well as a larger tax credit. For more information about this item, please contact: Paul Emrath at x8449 (pemrath@nahb.com) Footnotes: [1] For example, Martin Feldstein articulates this view here: [2] This is the same process that is used for the existing District of Columbia Homebuyer Tax Credit. The credit will be claimed in IRS Form [3] The ratio equals to average value of a new custom single family home divided by average value of a new single family for sale home using 2005 American Housing Survey (AHS) data. The AHS is conducted by the Census Bureau and funded by the Department of Housing and Urban Development.

8 [4] NAHB has submitted comments to the Department of the Treasury on this issue, recommending flexibility. These comments can be seen at the following link: aspx?contentid= [5] Elliot Eisenberg. Characteristics of First-time Buyers ( 4&genericContentID=88533&channelID=311). Housing Economics Online, January, 2008 [6] See [7] Modified adjusted gross income is defined by the tax code. To find it, a taxpayer must first determine adjusted gross income or AGI. AGI is total income for a year minus certain deductions (known as adjustments or above-the-line deductions ), but before itemized deductions from Schedule A or personal exemptions are subtracted. On Forms 1040 and 1040A, AGI is the last number on page 1 and first number on page 2 of the form. For Form 1040-EZ, AGI appears on line 4 (as of 2007). Note that AGI includes all forms of income including wages, salaries, interest, dividends and capital gain income. To determine modified adjusted gross income (MAGI), add to AGI certain amounts such as foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions and deductions for higher-education costs. [8] The eligibility date is determined by the date of purchase, which for the purposes of the tax code and the home buyer credit is the date when the transfer of title to the principal residence occurs. The date of sales contracts (including contracts for future transfer of title, such as lease to purchase contracts) may not be used because these contracts do not generate a home purchase on that date. The title must transfer before July 1, For homes being built by the taxpayer, perhaps through a general contractor, and not purchased directly from a builder, the date of purchase is defined as the date the home is first occupied. [9] NAHB is in discussions with these agencies to explore the possibility of updating these guidelines for the purpose of the tax credit program. [10] This option is discussed more here: [11] The MCC program was examined in a previous Housing Economics Online article: org/generic.aspx?genericcontentid= The statute for the buyer credit states that buyers may not use the tax credit when benefiting from the proceeds of section 103 debt issues (tax-exempt bonds). It is unclear whether MCCs are disqualified. The argument in favor of using MCCs with the first-time home buyer tax credit is that MCCs are authorized by section 25 of the tax code, not section 103, despite the fact that they are obtained by trading private activity bond authority for MCC authority. NAHB has requested additional information from the Department of the Treasury on this issue, and has argued MCCs may be used with the tax credit.