Tax Credit 101

Here are some commonly asked questions about the federal government’s Worker, Homeownership, and Business Assistance Act of 2009, which was set to expire last November but was extended to encompass home sales taking place before April 30 for this year. It offers $8,000 tax credits to first-time buyers and $6,500 to many repeat buyers.

Q. Who is eligible to claim the $6,500 tax credit?
A. Qualified move-up or repeat homebuyers purchasing any kind of home are eligible.

Q. What’s the definition of a move-up or repeat homebuyer?
A. The law defines a qualified move-up or repeat buyer as a person who has owned and lived in the same home for at least five consecutive years of the eight years prior to applying. For married homeowners, both spouses must qualify. Despite the connotation of “move up,” buyers don’t have to purchase a home that’s more expensive than their previous home to claim the credit.

Q. How is the amount of the tax credit determined?
A. The credit is equal to 10 percent of the home’s purchase price, up to a maximum of $6,500. Purchases of homes priced above $800,000 are not eligible.

Q. Are there any income limits for claiming the tax credit?
A. Yes. The income limit for single taxpayers is $125,000; for married taxpayers filing a joint return it’s $225,000. The credit amount is reduced for buyers with a modified adjusted gross income (MAGI) above those limits. The phaseout range for the program is equal to $20,000. That is, the credit amount is reduced to zero for taxpayers with a MAGI of more than $145,000 (single) or $245,000 (married) and is reduced proportionally for taxpayers with MAGIs between these amounts.

Q. What is “modified adjusted gross income”?
A. Modified adjusted gross income, or MAGI, is defined by the IRS. Naturally, then, it’s complicated. To find it, a taxpayer must first determine adjusted gross income, or AGI. AGI is total income for a year minus certain 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 the first number on page 2. For Form 1040-EZ, AGI appears on line 4. Note that AGI includes all forms of income including wages, salaries, interest income, dividends and capital gains.

Q. If my modified adjusted gross income (MAGI) is above the limit, do I qualify for any tax credit?
A. Possibly. It depends upon your income. Partial credits of less than $6,500 are available for some taxpayers whose MAGI exceeds the phaseout limits.

Q. Can you give me an example of how the partial tax credit is determined?
A. Got a calculator handy? Just as an example, assume that a married couple has a modified adjusted gross income of $235,000. The income limit to qualify for the credit is $225,000, so the couple is $10,000 over this amount. Dividing $10,000 by the phaseout range of $20,000 yields 0.5. When you subtract 0.5 from 1.0, the result is 0.5. To calculate the amount of the partial credit available to this couple, multiply $6,500 by 0.5. The result is $3,250.

Q. I’m not sure I get it. I need another example.
A. Okay, let’s do another one with an individual, not a couple. Let’s say an individual homebuyer has a modified adjusted gross income of $138,000. That figure exceeds the income limit of $125,000 by $13,000. Dividing $13,000 by the phaseout range of $20,000 yields 0.65. When you subtract 0.65 from 1.0, the result is 0.35. Multiplying $6,500 by 0.35, you get $2,275.

Q. How do I claim the tax credit? Do I need to complete a form or application? Are there documentation requirements?
A. You claim the credit on your federal income tax return. Specifically, buyers should complete IRS Form 5405 to determine the credit amount and then claim this amount on line 67 of Form 1040. No other applications are required and no pre-approval is necessary. However, you can’t claim the credit on Form 5405 for an intended purchase at some future date; it must be a completed purchase—and you must attach a copy of your HUD-1 settlement form as proof.

Q. What types of homes will qualify for the tax credit?
A. Any home that will be used as a principal residence will qualify for the credit, provided the home is purchased for a price less than or equal to $800,000. Even a house-
boat counts, if you intend to live on it. But you can’t qualify if you buy a home from a family member, your spouse or a member of your spouse’s family.

Q. I read that the tax credit is “refundable.” What does that mean?
A. The fact that the credit is refundable means that it can be claimed even if the taxpayer has little or no federal income tax liability. Typically this involves the government sending a check for a portion or even all of the amount of the credit.

Q. Okay, I need another example.
A. Sure. Let’s say a qualified home-buyer expected, notwithstanding the credit, federal income tax liability of $5,000 and had $4,000 withheld. Without the credit the taxpayer would owe the IRS $1,000. If that same taxpayer qualified for the credit, he or she would receive a check for $5,500 ($6,500 minus the $1,000 owed).

Q. Instead of buying a new home from a homebuilder, I hired a contractor to build a home on my lot. Do I still qualify for the tax credit?
A. Yes. For the purposes of the credit, a principal residence constructed by the homeowner is treated by the tax code as having been “purchased” on the date it’s first occupied. In this situation, that date must be after November 6, 2009 and on or before April 30, 2010. Or the date could be June 30, 2010 provided a binding sales contract was in force by April 30, 2010.

Q. I’m not a U.S. citizen. Can I claim the tax credit?
A. Probably. A nonresident alien (as defined by the IRS) who meets the same requirements that U.S. citizens meet can claim the credit. The IRS provides a definition of “nonresident alien” in IRS Publication 519.

Q. Is a tax credit the same as a tax deduction?
A. No. A tax credit is a dollar-for-dollar reduction in what the taxpayer owes. That means that a taxpayer who owes $6,500 in income taxes and who receives an $6,500 tax credit would owe nothing. A tax deduction is subtracted from the amount of income that’s taxed.

Q. Is there a way to access the money allocable to the credit sooner than the deadline for filing 2009 or 2010 tax returns?
A. Yes. Prospective buyers who believe they qualify for the credit are permitted to reduce the amount of their income tax withholding. Reducing the amount withheld up to the amount of the credit will enable the buyer to accumulate cash by raising his or her take-home pay. This money can then be applied to the down payment.

Q. HUD allows “monetization” of the tax credit. What does that mean?
A. It means that HUD will allow buyers using FHA-insured mortgages to buy homes and apply the anticipated credit immediately rather than waiting for refund checks. Also, non-profits and FHA-approved lenders are allowed to give homebuyers short-term loans. Government agencies, such as state housing finance authorities, may provide longer term loans secured by second mortgages. Check out www.federaltaxcredit.com for more detailed information.

Q. If I’m qualified for the tax credit and buy a home in 2009 or 2010, can I apply the tax credit against my 2008 or 2009 tax return?
A. Yes. The law allows taxpayers to treat qualified home purchases in 2009 or 2010 as if the purchase occurred on December 31, 2008. That means the previous year’s income limit (MAGI) applies. A benefit of this approach is that a homebuyer in 2009 or 2010 will know his or her prior year MAGI with certainty, thereby allowing an exact determination of the credit amount.

Q. How can two unmarried buyers allocate the tax credit if one qualifies for the $8,000 first-time homebuyer tax credit and the other qualifies for the $6,500 repeat homebuyer credit?
A. The buyers can allocate the credit in any reasonable manner, provided neither claims a credit higher than the one they qualify for, and provided the home purchase doesn’t yield a total of more than $8,000. For example, the repeat homebuyer could claim $6,500 and the first-time homebuyer could claim $1,500. Or, both buyers could claim a $4,000 tax credit.