The First Time Homebuyers Tax Credit

The First Time Homebuyers Tax Credit

I'm helping my daughter and son-in-law with their taxes, and as a result, I have had some occasion to look at this new "first time homebuyers tax credit." It looks like a good deal, but it isn't, in any conventional sense, a tax credit. A more accurate description is that the government is making you a 0% loan of $7500 to buy a house--even though you pretty much needed a down payment to buy a house. They aren't fronting you the money, so it's a loan only for loose definitions of "future" and "past."

It turns out that unless you have a pretty high income (or a very average income in California or New York City), if you and your spouse or partner haven't owned a house in the last three years, and you buy one, you will get $7500 back on your federal tax return--even if your total tax liability is zero! For many people who bought a first house in 2008 (especially those with incomes below $40,000), the combination of interest payments and property taxes means that they have little or no federal tax liability anyway, so they get most or all of their federal withholding back--plus $7500.

So why isn't this a refundable tax credit in the conventional sense? Because it is actually a loan. If you sell the house, you have to repay the $7500 in the applicable tax year. If you don't sell the house, after two years, you have to start paying the $7500 back, over a 15 year period. So if you take the tax credit on your 2008 tax return, when you file your 2010 tax return, your taxes will include a $500 payment, and so on until the $7500 is repaid, or you sell the house.

This is potentially quite dangerous if you scraped together the down payment to get into the house, get this $7500 windfall, and decide that you need a small scale Sony Jumbotron for the house--and then, a couple years down the road, you suddenly have to sell the house. Now you need that $7500 to repay the government when you file your tax return for the year that includes the house sale.

On the other hand, if you put that $7500 into a bunch of $500 CDs, and pay back the $500 every year with one of those CDs, you are perfectly safe. You've got the money to pay back the 0% loan; you are earning interest on it over those 15 years; and if you sell the house in the meantime, even if you don't make any money on it, you still have the money in CDs with which to pay back Uncle Sam. You will actually come out ahead.

If there weren't so many people who have done stupid things involving houses (and 401k funds) over the last few years, or if you could be sure that once you have bought a house, you would not be moving out of the area suddenly, I wouldn't worry too much about this program. But I have a weird feeling that a more than a few people are going to fill in the paperwork, get the $7500 windfall, and spend it in ways that will make drunken sailors look responsible--and there's going to be a nasty fall, several years down the road.

As I mentioned at the start, this is phrased by the IRS as a form of loan to first time homebuyers. But normally you can't buy a house without money in hand. You can't borrow it from family or friends, and you can't cash advance your credit card to get the down payment. If family provides the funds, it has to be a gift, or it is no good. So what is this talk about being a loan to help first time homebuyers? It almost looks like the government is encouraging people to lie about receiving a gift from relatives for the down payment, and then, after they have moved in, using this "refundable tax credit" to pay back the "gift" to relatives.

But what the heck, the whole last several years of subprime mortgage insanity has been an elaborate piece of deception and chaos. Why not add some more to the mess?