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Tax Provisions of the Housing and Economic Recovery Act of 2008

By Roger T. Whitaker

On July 30, 2008 President Bush signed the Housing and Economic Recovery Act of 2008 which was enacted by Congress as a reaction to weakness in the residential real estate market and problems in the credit markets. A portion of the Act, known as the Housing Assistance Tax Act of 2008, contains tax provisions which may benefit first time home buyers at the expense of taxpayers who sell property previously used as vacation or rental property.

Is it a Credit or a Loan? It’s a credit. For homes purchased by first time home buyers after April 9 and before July 1, 2009 a temporary, refundable tax credit equal to 10% of the purchase price of the home, up to $7,500 ($3,750 for married individuals filing separately) may be available. The full credit is available for married couples filing jointly with modified adjusted gross income under $150,000 and for single taxpayers with modified adjusted gross income under $75,000. The credit will phase out between $150,000 and $170,000 for married couples and between $75,000 and $95,000 for single taxpayers.

A person is considered a first time home buyer if he or she (or spouse) had no ownership interest in a principal residence during the three year period before the new home is purchased.

Two or more unmarried individuals may purchase a residence and qualify for the credit however they must allocate the amount of the credit between them as the IRS will prescribe. The total amount of the credit allowed to the individuals jointly may not exceed $7,500.

The credit may be claimed on a 2008 or 2009 tax return. If a first time buyer purchases a residence in 2009 after filing a 2008 return, he or she will have the option of filing an amended 2008 return to claim the credit. If an amended return is not filed, the taxpayer may be able to adjust withholding to take advantage of the credit before filing the tax return.

It’s a Loan. The first time home buyers credit differs from other federal tax credits because it must be repaid. Taxpayers who claim the credit will have 15 years to repay the credit, interest free. Repayments must begin two years after claiming the credit and will be spread over a 15 year period. For taxpayers claiming the credit on a 2008 return, payments will begin in the year 2010 and end in 2024. Repayment is made in the form of a “recapture” of the applicable portion of the credit as an additional tax on each tax year’s return. If a residence is sold or no longer used as the principal residence prior to full repayment of the credit, the unpaid balance will be due in the year of sale. To protect against further deterioration in the real estate values, the credit may not exceed the amount of gain from the sale of the residence to an unrelated person. A taxpayer’s estate will not be liable for repayment of the balance of the credit if the taxpayer dies prior to the expiration of the 15 year period.

Property Tax Deduction. Under current law in order to claim a deduction for real estate taxes a taxpayer must itemize deductions. The tax portion of the Housing Assistance Tax Act of 2008 gives non-itemizers a limited deduction for state and local real property taxes by increasing the standard deduction by the lesser of the amount of taxes paid during the year or $500 ($1,000 for a married couple filing jointly). This deduction is available only for 2008.

Sale of Vacation Property. Current law allows taxpayers to exclude gain of up to $250,000 ($500,000 for joint filers) on the sale of their principal residence. Taxpayers who had two homes were able to sell the principal residence, move into the second home, live in it as a new principal residence for two years and claim the exclusion on a subsequent sale of the second home. If the second home had been used as a rental property, the prior rental usage was disregarded as long as the taxpayer lived in the home as a principal residence for at least two years prior to the sale.

The Housing Assistance Tax Act of 2008 forecloses the use of that planning technique. Gaining from the sale of a principal residence will no longer be excluded from gross income for periods that the home was not used as the principal residence. Only nonqualified use incurring on or after January 1, 2009 will be taken into account in applying this new rule. Gain will be apportioned between periods of nonqualified use and periods of qualified use.

The amount of gain allocated to periods when the property was not used as a principal residence is the amount of gain multiplied by a fraction, the numerator of which is the total period of nonqualified use during which the property was owned and the denominator of which is the period the taxpayer owned the property.

Example. John buys property on January 1, 2009 for $400,000 and rents it for two years, claiming $20,000 of depreciation. On January 1, 2011, John begins to use the property as his primary home. He moves out of the house on January 1, 2013 and sells it for $700,000 on January 1, 2014. The period 2009-2010 when John used the property as a rental is nonqualifying use. The year 2013, after John moved out, is treated as qualifying use because a period of absence generally counts as qualifying use if it occurs after, not before, the property was used as the principal residence. Of the $300,000 gain realized on the sale, 40% (two years out of the five years owned), or $120,000 is not eligible for the exclusion. The balance of the gain, $180,000, may be excluded. The amount of the gain attributable to depreciation is recaptured, as required under current law.

If you have questions about how these new provisions may affect your tax situation please contact your adviser at Luper Neidenthal & Logan.

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