The Trusted Adviser October 2009 | Volume 2 - Number 8


Time is Running Out: First-Time Homebuyer Tax Credit
by Frederic Deraiche, ATG Law Clerk

As part of the American Recovery and Reinvestment Act of 2009, the first-time homebuyer's tax credit was expanded and modified from its 2008 design into a more alluring form. As it currently stands, the 2009 first-time homebuyer's tax credit is due to expire on December 1, 2009. 26 USCA 36. For buyers to be eligible for the credit, they must have fully closed the transaction and have assumed full ownership by that date.Id.Buyers must act fast if they hope to redeem the credit before it expires.

The goal of this program is to foster recovery in the real estate market by serving as a strong incentive to those who do not currently own their own homes to enter the real estate arena. In addition to serving as a renovation of the 2008 scheme, the 2009 credit is different from many of the previous government programs in the real estate sphere and serves different goals than many of these previous attempts. However, some questions remain as to this credit's application as well as to its effect.

Changes Since 2008

The tax credit for first-time homebuyers was originally introduced in 2008 through the Housing and Economic Recovery Act of 2008. Housing and Economic Recovery Act of 2008, &§ 3011, Pub L 110-289, 122 Stat. 2878 (2008), codified at 26 USC &§ 36. The credit reduced a taxpayer's tax bill or increases his or her refund, dollar for dollar and was equal to the lesser of 10% of the purchase price of the home or $7,500 ($3,750 if married filing separately). It was effective for homes purchased by eligible first-time homebuyers after April 8, 2008, and before July 1, 2009. The credit was repayable to the Internal Revenue Service (IRS) over fifteen years. Housing and Economic Recovery Act of 2008, &§ 3011, 122 Stat. 2878. In practice, the credit amounted to an interest-free loan from the U.S. government.

The credit was subsequently modified by the American Recovery and Reinvestment Act of 2009 and extended to December 1, 2009. In addition to being extended, the newly increased credit was also applied retroactively to all purchases on or after January 1, 2009, The 2009 credit's cap has been increased to $8,000 and it no longer requires repayment unless the purchased home ceases to be the taxpayer's principal residence within 36 months of the purchase. 26 USCA &§ 36.


The basic requirements of the 2009 credit are that the purchase of the home occurs during the stated period (after April 8, 2008, and before December 1, 2009), that the purchaser is a first-time homebuyer, and that the home is the purchaser's principal residence. For the purpose of this credit, a first-time home buyer is one who has not owned his or her principal residence during the three-year period preceding the purchase. For married couples, both the primary purchaser and the spouse must meet this requirement.

The home may not have been purchased from a related person — spouse, direct descendant (children, grandchildren), or ancestor (parent, grandparent) — or from a corporation or partnership in which the purchaser owns more than 50% interest.

Phaseout of the credit starts for those with an adjusted income of $75,000 for individuals and $150,000 if married filing jointly; those earning $95,000 or more (individuals) or $170,000 (married) are not eligible.

As of July 2, 2009, the IRS has declared that purchasers under land contracts may apply for the credit under certain circumstances.First-Time Homebuyer Credit Questions and Answers: Basic Information, Internal Revenue Service. According to this IRS publication, buyers under land contracts may claim the credit if they assume the benefits and burdens of ownership prior to December 1, 2009, even though the seller will retain legal title until the loan is repaid.Id.The publication further describes the following seven factors that would show that the taxpayer has assumed the benefits and burdens of ownership:



"1. the right of possession, 2. the right to obtain legal title upon full payment of the purchase price, 3. the right to construct improvements, 4. the obligation to pay property taxes, 5. the risk of loss, 6. the responsibility to insure the property and 7. the duty to maintain the property."

Id.As such, many land contract transactions would allow the buyer to claim this credit as a result of this new policy.

Collecting the Credit

The 2009 first-time homebuyer's credit can be collected in a variety of ways depending on the situation. Under no circumstance, however, can the credit be collected prior to the purchase of a home.

Those who purchased in 2009 and filed a 2008 return claiming $7,500 based on the prior law should amend their tax return to claim the balance of the credit. Use Form 1040X withIRS Form 5405.

Those who purchased in 2009 under the new law will claim the credit using IRS Form 5405 as part of their 2009 income tax filing in April 2010.Expanded Tax Break Available for 2009 First-Time Homebuyers, Internal Revenue Service, IR-2009-14, February 25, 2009 (last reviewed or updated April 17, 2009).

In addition, the Department of Housing and Urban Development allows for the loans based upon the tax credit, or the outright purchase of the credit. This policy is effective as of May 29, 2009, as detailed in theMortgagee Letter 2009-15(Department of Housing and Urban Development, May 29, 2009). This allows certain government agencies and instrumentalities to advance the tax credit in the form of a second lien. This lien cannot provide cash back to the borrower, nor exceed the sum of the down payment, closing costs, and prepaid expenses.

Alternatively, FHA-approved mortgagees, nonprofit organizations, and governmental agencies can purchase the anticipated tax credit from the homebuyer.Id.In such cases, the fees and costs cannot amount to more than 2.5% of the expected credit. In addition, the homebuyer must certify that the credit is not subject to other indebtedness.

In either alternative, the minimum down payment of 3.5% required for the FHA to insure a mortgage cannot be provided by "the mortgagee, the seller, &€¦ any other person or entity that financially benefits from the transaction or by any third party or entity that is reimbursed, directly or indirectly, by the financially benefiting person or entity."Id.Therefore, such a sale of tax credit is not sufficient to meet the 3.5% requirement for FHA loans. The credit, however, may be used as additional downpayment beyond the minimum requirement, or can be applied to closing costs and/or buying down the interest rate.

How is it different from previous government initiatives?

The guideline that the minimum FHA-required down payment may not come from persons or entities financially benefiting, or those who would be reimbursed by such persons is a reference to the ill-fated seller-funded down payment assistance (SFDA) programs. SFDA allowed buyers to fund their downpayments through charitable organizations that received funds directly from the seller. Government Accountability Office,MORTGAGE FINANCING Seller-Funded Down-Payment Assistance Changes the Structure of the Purchase Transaction and Negatively Affects Loan Performance, GAO-07-1033T, 3-4, June 22, 2007. To recoup their gifts, sellers would simply increase the price of the home, inflating prices 3. These inflated prices as well as the low buyer equity created loans that had a very high incidence of 4.

Economists have compared the effects of mortgage interest deductions (MID) with those of a first time homeowner tax credit and have found that the credit compares favorably. William G. Gale, Jonathan Gruber, Seth Stephens-Davidowitz,Encouraging Homeownership Through the Tax Code, Tax Notes 1171 (June 18, 2007). Some even suggest replacing the MID with the credit, rather than having the two work 1182. They argue that the MID has shown little effect on homeownership, whereas a credit has, both in practice in other countries as well as empirically, generally proven effective in increasing homeownership 1179, 1185.

Potential Effects

As part of the American Recovery and Reinvestment Act of 2009 package, the first-time homebuyer's credit aims at recovery in the real estate market. Any significant tax policy is likely to have other effects, however, such as in the realms of homeownership rates, federal revenue, population demographics, tax progressivity, etc.

In considering the effects of a similar proposal, some economists have found that the costs on the government of a tax credit such as this are generally lower than those of current homeownership incentive programs, such as the mortgage interest reduction program. Gale, Tax Notes at 1184. While the size of the credit considered by economists in that study were less generous than those now in place-$3000 for single individuals, and $6000 for married couples, compared to $8000 in the current program-they nevertheless found that applying such a credit to all first-time buyers, regardless of income, would still cost less than mortgage interest reduction.Id.

Economists for the Congressional Research Service have further estimated that the $8000 credit could lead to a 3.40-5.68% reduction in the annual costs of homeownership, depending on the region the homeowner lives in. Mark P. Keightley, "The First-Time Homebuyer Tax Credit: An Economic Analysis,Congressional Research Service, February 19, 2009. The same economists further posit that the price-elasticity for homeownership as opposed to renting may be near 1; that is to say that a 1% decrease in ownership costs will, theoretically, be matched with a 1% increase in the probability that a given renter will become a homeowner.Id.The uncertainty of potential buyers will decidedly affect this elasticity, which was calculated through data collected prior to the current economic environment. The possibility exists that the buyer's wait for price stabilization might extend beyond the length of credit availability.Id.

Though previous first-time homebuyer tax credits such as the Washington, D.C. credit have led to an increase in the price of homes targeted at first-time buyers, this result is not expected with the 2009 credit.Id.Because the supply of homes is so high as compared to the demand, the sellers do not have the proper position to increase prices in an attempt to "capture" the amount of the credit. Furthermore, the credit is described as a progressive approach, having the greatest effect in reducing taxes for the lowest income. This effect is further enhanced by evidence of similar credits having success in targeting low-income individuals.Id.

Remaining Questions

Despite the 2009 credit having been available for several months and nearing its expiration, many questions remain. The ultimate question, what effect has the credit had on the economy and on the real estate market, has not been answered fully.

Data collected by Penn, Schoen & Berland Associates for Century 21 Real Estate, LLC, implies that the hoped-for results may very well come to fruition. In a poll of potential first-time homebuyers, the polling firm found that 73% were considering homeownership due to the low prices ("Century 21 Real Estate First-Time Home Buyer Survey Reveals Increasing Demand Despite Concerns about the Economy,", March 26, 2009). This was attributed in part to the tax credit, which can be used to help reduce the effective price of a house. Not all findings were positive, however. The study found that 48% of individuals polled were, while in the market for their first home, still reluctant to immediately purchase a house due to expectations of further drops in price.Id.In light of the self-fulfilling nature of markets such as real estate, such findings may imply that the desired effect is not yet taking place and will not be immediately forthcoming. Ultimately, the true effects of the credit on the real estate market will remain to be seen and will be hard to truly ascertain even once the credit period has ended.

Potential Renewal

There is some talk, especially amongst lobbyists, about a renewal or extension of the first-time homebuyer's credit. See Steve Cook, "Will Greed Kill the First-Time Homebuyer's Program?"Real Estate Economy Watch, August 26, 2009; Kevin Post, "Rush to get $8,000 first-time homebuyer tax credit boosts area home purchases,", August 30, 2009. However, it is uncertain whether such an extension will ever take place. Though several bills have been introduced before Congress, none has made any headway. See for example H.R. 2801, 111th Cong. (June 10, 2009); H.R. 2905, 111th Cong. (June 16, 2009); S. 1678, 111th Cong. (Sept 16, 2009). It is unclear what the chances of renewal are for this credit. For the moment, the credit is due to expire on December 1, 2009, and all homebuyers who wish to claim this credit must have fully closed their transaction by that date.








THE TRUSTED ADVISER is published by Attorneys’ Title Guaranty Fund, Inc., P.O. Box 9136, Champaign, IL 61826-9136. Inquiries may be made directly to Mary Beth McCarthy, Corporate Communications Manager. ATG®, ATG® plus logo, are marks of Attorneys’ Title Guaranty Fund, Inc. and are registered in the U.S. Patent and Trademark Office. The contents of the The Trusted Adviser © Attorneys' Title Guaranty Fund, Inc.

[Last update: 10-14-09]