Countering the Slump New Housing Assistance Tax Act Is a Mixed Bag for Taxpayers

The act contains $15.1 billion in tax incentives targeted principally to homeowners and affordable housing investors. Its another shot to further remedy the housing market slump and to help some 400,000 homeowners avoid foreclosure. It also closes a loophole which currently allows homeowners an exclusion on the gain from the sale of a principal residence previously used for other purposes.

The legislation is very broad and complex, and this article will focus only on certain aspects that are likely to directly affect physicians, dentists, and their families.

First-time Homebuyer Tax Credit

The act gives first-time homebuyers a temporary refundable tax credit equal to 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the purchase price of a home, not to exceed $7,500 ($3,750 for married individuals filing separately).

The credit is effective for principal residences purchased on or after April 9, 2008 and before July 1, 2009. A principal residence is where you reside most of the year and where you claim residency for income tax, voting, driver’s license, etc. The credit phases out for married couples filing jointly with modified adjusted gross income (AGI) between $150,000 and $170,000 and for single taxpayers with modified AGI between $75,000 and $95,000.

To qualify as a ‘first-time homebuyer,’ a person (or spouse) must not have had an ownership interest in a principal residence during the three-year period before the purchase of the new home. If you rent your principal residence, you may qualify for the credit even through you may own a vacation home, since the three-year lookback period applies only to a principal residence.

Homebuyers claiming the credit may not acquire the property from certain related persons, and they must satisfy certain basis rules. The credit must be claimed on your 2008 or 2009 tax return, but if you purchase the home in 2009 after filing your 2008 tax return, you may file an amended 2008 tax return instead of waiting until 2010 to claim the credit on your 2009 tax return.

There is a catch to this, though, which makes it unlike any other federal tax credit. Taxpayers must repay the credit in equal installments over 15 years, which makes this more like an interest-free loan than a tax credit. If the taxpayer sells the home before the credit is fully repaid, the unpaid balance is due in full during the year of the sale, but is limited to the lower of the credit balance or taxable gain on the sale.

Also, if the taxpayer retains but no longer uses the house as a principal residence, the unpaid balance is due in full during that year. The credit balance does not have to be repaid if the taxpayer dies. There are special rules that apply for involuntary conversions and divorce settlement transfers.

First-time homebuyers who have had the patience and tenacity to save and wait out the housing boom are in an enviable position to take advantage of the buyers’ market. This author can’t help question, however, why Congress believes that this so-called credit is going to have a positive impact. It doesn’t provide any cash up front for a down payment and requires the taxpayer to repay it. It entices first-time homebuyers, most of whom are young couples, to incur additional debt, albeit interest-free, to spend on something other than their new home.

Property Tax Deduction for Non-itemizers

Under current tax rules, only individuals who itemize deductions may deduct real-estate taxes. The new law gives nonitemizers a limited deduction for state and local real property taxes by increasing the amount of their standard deduction by the lesser of the amount of real property taxes paid during the year, or $500 ($1,000 for a married couple filing jointly).

This temporary deduction is available only for 2008. The new deduction is in addition to the standard deduction. It is not an above-the-line deduction that lowers the amount of a taxpayer’s AGI.

Taxpayers who have previously ceased itemizing deductions because they have paid off their home mortgage loans and no longer have a large interest deduction may now get more than the standard deduction.

Loophole on Principal Residence Sales Closed

Under current law, taxpayers who file jointly may exclude up to $500,000 of gain ($250,000 for single taxpayers) realized on the sale or exchange of their personal residence, as long as it was owned and used as their principal residence for two or more out of the five years preceding the date of sale. The two-year period does not have to be continuous, but can be several periods which, during the five-year period, aggregate to 730 days of principal residence use.

Short, temporary periods of absences such as vacations and seasonal absences are counted as periods of use. However, an absence of an entire year is not considered a short, temporary absence. There are special rules and exceptions for failure to meet this test by reason of a change of place of work, health, unforeseen circumstances, or duty in the uniformed services, the U.S. foreign service, or the intelligence community.

For home sales after Dec. 31, 2008, this two-out-of-five-year rule still applies. Gain, however, from the sale of a personal residence will no longer be excluded for periods that the home was deemed not to have been used as the principal residence (‘non-qualified use’).

The amount of gain allocated to periods of non-qualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate period of non-qualified use during which the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. ‘Non-qualified use’ for this computation does not include any use prior to 2009.

There are two transitional rules that provide some relief to current owners. First, the calculation will consider only non-qualified use periods that begin on or after January 1, 2009. Second, a period of absence generally counts as a qualifying use if it occurs after the home was used as a principal residence.

Example: Terri buys property on Jan. 1, 2008 for $400,000 and rents it for three years, claiming $50,000 of depreciation. On Jan. 1, 2011, Terri begins to use the property as her principal residence. She moves out of the house on Jan. 1, 2013 and sells it for $700,000 on Jan. 1, 2014. The year 2008 is excluded from the non-qualifying use period because it predates 2009. The year 2009 is non-qualifying use. The year 2012, after Terri moved out, is treated as qualifying use. Terri has to recognize $50,000 of gain attributable to depreciation deductions previously taken. Of the remaining $300,000 gain, 33{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} (two years out of six years owned), or $100,000, is not eligible for the exclusion. The balance of the gain, $200,000, may be excluded.

Tax-planning Tips

With the housing market in a slump, it is not likely that many readers will be selling their homes anytime soon, but if you are looking to make a future move, there are planning measures you should consider now.

First, because of the size of the gain exclusion, most homeowners previously disregarded keeping track of the costs of significant improvements to their homes. Now that the allowable exclusion could be less than the maximum, accurate tracking of basis could be important in minimizing taxes.

Second, if you own a vacation home that you intend to convert to your principal residence, the timing of the move and the sale of your current residence could have significant tax implications. The best time to convert your vacation home to your principal residence is prior to Jan. 1, 2009.

Third, if you move because of a change in employment but hold onto your home and later move back in, it could have tax consequences. For these reasons, it is more important than ever to consult with your accountant or tax preparer before making any moves.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers Kalicka, P.C., in Holyoke, certified public accountants and business consultants; (413) 536-8510.