First Time Home Buyer Credit: What Exactly is It?

The First Time Home Buyer Tax Credit has been getting a lot of attention in the news recently. As part of the American Recovery and Reinvestment Act of 2009, the credit is designed to incentivise certain tax payers to purchase a new home, and help revitalize the US housing market. It is, in fact, a new and improved version of the previous years home buyers tax credit, which was part of the Housing and Economic Recovery Act of 2008. In this guide we will cover both of these tax credits and answer some common questions concerning the differences, who is eligible and what is covered.

Tax Credit vs. Tax Deduction

For anyone considering the tax implications of either of the two first time home buyer tax credits (discussed in detail next), the one question that always arises is, "what is the difference between a tax deduction and a tax credit?". The difference is actually substantial. 

Take the following (overly simplistic) example: A consumer earning $50,000 per annum, and paying %30 in income tax, will owe $15,000 in income tax. Now, if that same consumer were to receive a $7,500 tax deduction, he or she would subtract $7,500 from the taxable amount of $50,000, for a new taxable amount of $42,500 and now owe $12,750. A tax credit, on the other hand, is a dollar for dollar credit towards payable income tax. So in our above example, the $7,500 would be credited directly towards the $15,000 owed, for a new payable income tax of $7,500.

Basically, a tax credit will save you exactly the amount credited, and a tax deduction will save you the percentage of tax multiplied by the credit amount. In the above case its: 30% times $7,500, netting a $2,250 actual savings.

Earlier Tax Incentives for Home Buyers

Before the 2008 Housing and Recovery Act, home buyers had two major tax incentives. One was the home mortgage interest deduction, and the other was the fact that any capital gains earned on the sale of your primary residence were tax free. Both of these are benefits that homeowners still enjoy.

Deducting Mortgage Interest from Taxable Income

The IRS allows tax payers to deduct the interest paid on their home or secondary residence. In order to benefit from this deduction, home owners must elect to itemize their deductions, and the total of the itemized deductions must exceed the standard deduction, otherwise their would be no reduction in payable tax.

Tax Free Capital Gains on the Sale of a Primary Residence

The Internal Revenue Service allows a homeowner to exclude up to $250,000 ($500,000 for married couples that file jointly) of any gain in capital made from the sale of a primary residence. The one rule is that the owner(s) must have lived in the residence for at least two of the five years prior to the sale to be eligible for the tax deduction.

The First Time Home Buyer Tax Credit of 2008

In 2008, homeowners were treated to a $7,500 tax credit if they purchased a new home between April 9, 2008 and January 1, 2009. The tax credit was a first attempt to address the sub-prime mortgage crisis, and was passed by Congress on July 24th, signed by then President George W. Bush.

2008 First Time Home Buyer Tax Credit  Eligibility

This credit was available to First Time home buyers, on any kind of home, new or resale. Under this act, a "first time home buyer" was anyone who had not owned their principle residence in the three years prior to purchase. For married couples purchasing a home, both spouses must pass this test.

The Tax Credit was available to tax payers earning a "modified adjusted gross income" of $75,000 or less, and married couples filing jointly with a combined gross income of $150,000 or less.

Actual Amounts and Repayment

One of the key factors that everyone should be aware of regarding the 2008 credit, is that it must be repaid. The repayment is interest free, and scheduled over 15 years, at $500 per year, beginning two years after the credit is claimed. If the home is sold within that 15 year time frame, then the credit must be repaid , in full, at that time if there is enough capital gain on the sale to cover it. This makes the 2008 tax credit, essentially, an interest free loan.

Another thing to consider is that, for homes purchased for less than $75,000, the credit will be 10% of the purchase price.

2009 First Time Home Buyer Tax Credit

In February of 2009, new President Barack Obama singed into law the American Recovery and Reinvestment Act of 2009. One of the key features of this act was that it included a new and improved version of the First Time Home Buyer Tax Credit.

2009 First Time Home Buyer Tax Credit Eligibility

This new version of the tax credit is available to first time home buyers (defined the same as the previous version) who purchase a home between January 1, 2009 and December 1, 2009. Income limits remain the same as the prior credit.

Amounts and Repayment

The biggest difference between this new tax credit and the prior credit, is that it does not have to be repaid. Additionally, the credit amount was increased by $500 to $8,000.

There are additional details regarding both tax credits that are outside the scope of this guide. For more information, consider talking to a financial advisor or your tax attorney.