Wednesday, September 3, 2008

The New $7,500 Tax Credit

Just what is the new first-time buyer $7,500 tax credit, and how beneficial is it? It is part of the Housing and Economic Recovery Act of 2008, and was included to provide benefit to the consumer to offset the appearance of the bill as being nothing but a bail-out for financial institutions. Calling it a tax credit is also something of a misnomer, because it is in actuality an interest free 15 year loan. This is not to say that it has no benefit to those who may be eligible for it. In fact, the benefits can be significant, and those who take advantage of it have a built-in repayment plan.

A summary of the tax credit:
  • The credit is available to first time home buyers (single family residences, condos and coops). By definition, a first time home buyer is anyone who has not owned an interest in a home within the three years preceding the purchase of a qualifying home.
  • The income limit for eligibility is no more than $75,000 (individuals) or $150,000 (married couples filing jointly).
  • The amount of the credit and eligibility for it is 10% of the purchase price of a home bought and closed between April 9, 2008, and July 1, 2009.
  • The maximum credit is $7,500.
  • The credit is not automatic. The credit will need to be claimed at tax time in the year following the purchase (April 2009 and April 2010).
  • The credit (loan) will need to be repaid yearly at tax time at a rate of $500 per year (or 6.67% of the actual), or repaid in full (the out-standing balance) upon sale of the residence used to qualify for the credit.
One last feature that should be clarified is that the amount of the credit will be applied first to the tax liability of the claimant. Anyone claiming the credit who owes taxes above what they paid in will therefore reduce the amount due when they file their taxes or receive only that part of the credit above their taxes due. On the other hand, tax payers who are due a refund on over-payment of their taxes will receive the full amount of the credit for which they qualify.

Before jumping into this and claiming the tax credit, everyone should crunch their own numbers. The potential benefits for most appear to be worth taking the credit though. In example, consider a scenario wherein a qualifying couple with a child bought their first home for $120,000. The couple received a tax refund of $1,200 in the year before they bought their home and expects at the same in the coming year. They also maintain credit card debt balance of $8,000 at 12% interest, which they are repaying at the minimum each month. Without crunching the numbers, it should be pretty clear that paying off the credit card debt with the $8,700 refund check will benefit them significantly.

Remember, the tax credit is an interest-free loan over 15 years. Assuming that they can expect similar refunds during the 15 years during which they must repay the "credit," the repayment should not create additional problems. Moreover, they are now home owners—and the tax benefits of home ownership will afford them with an even greater reduction in their tax liability over the years to come.

Everyone's finances are not likely to fit this scenario, so the decision to claim the tax credit needs to be analyzed individually. Take the same young family in example, and assume that they did not maintain so large a credit card debt. Since their total debt was relatively low and manageable, they decide to take the tax credit and invest the $8,700 refund check as seed money in a college fund for their child.

There are scenarios in which taking the tax credit could become a liability. Make no mistake about that. Self employed individuals who routinely under estimate their taxes and must pay additional taxes each year will need to plan for the additional repayment of the tax credit. But the fact remains that money has value over time, and the majority of people who qualify for the new tax credit are likely to realize significant returns in an interest free loan over the next 15 years.

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