Beyond Paycheck to Paycheck

Not surprisingly, government has found another way to make something that could be so simple so very complicated.

You:  How so this time?

The relatively new first-time homebuyer tax credit.

You: Did this just come out because of the most recent financial crisis?

Actually, it came out a few months ago before the most recent financial crisis.  But it was definitely added in response to falling home prices.  Here’s what you need to know:

Qualification

In order to be eligible for the first-time homebuyer credit, you must meet the following conditions:

• You must buy a principal residence (not an investment property or a second home) after April 9, 2008 and before July 1, 2009.
• If you file single or as head of household, your modified adjusted gross income must be less than $95,000 to receive any credit (and less than $75,000 to receive a full credit).  If you’re married, those two numbers increase to $170,000 and $150,000 respectively.
• You must not have owned a principal residence during the last three years. Same is true for your spouse, if you are married.

Provided you meet all of the conditions above, here’s what the credit means for you:

Show Me The Money

Since the credit is 10% of your home’s purchase price but is subject to a maximum of $7,500, anyone who purchases a house costing $75,000 or more and meets the criteria above receives the same $7,500 credit.  Note, however that the credit is refundable. That’s huge.

You: Why?

The fact that the credit is refundable means that you can get the full $7,500 even if your total tax liability was less (or even zero). Many other credits are only actually payable if you would otherwise have a tax liability.

You: Okay, now in English.

Say your tax liability for the year is $1,500 and you had $2,000 withheld.  Ordinarily, you’d receive a $500 refund.

You: Easy enough.

Now, say that you’re eligible for the first-time homebuyer tax credit but that the credit was non-refundable.

You: But it is refundable.

Yes, but I’m trying to provide an example so you can understand the importance of the “hugeness.”

You: Right.

If it were non-refundable, your tax refund would increase to $2,000 because the credit would reduce your income tax liability to zero, providing you with a full refund of the entire amount you had paid through withholding.

You: But since, it’s refundable . . .

You get more.  In fact, you get the whole $7,500 credit.  The first $1,500 of it wipe away the tax you’d otherwise owe and the next $6,000 becomes “refundable.”  Plus, since you already paid $2,000 through withholding, the refund you’d actually receive would be $8,000.

You: That’s a huge refund.

Pun intended?

Then, The Government Takes It Back. Slowly.

You:  I don’t like the sound of that.

You shouldn’t.  What happens next makes the credit not really a credit and more of an interest-free loan:

Over the 15 years starting two years after you claim the credit, you have to pay 1/15 (or $500) back to the government each year.

You: What?  How?

You have to pay the credit back through a $500 reduction in your refund or a $500 increase in the amount due on each of 15 consecutive tax returns.

You: That doesn’t sound like a credit - it sounds like an interest-free loan.

It is. It’s just like the interest-free loan some people give to the government every year because of consistent over-withholding on their paychecks.  But this interest-free loan is a good thing because it’s you are the one who is not paying interest.  To be sure, an interest-free loan is not as good as a pure credit that you get to keep forever, but $7,500 is still a nice chunk of change in the form of an “interest-free advance” for the nominal effort of claiming it, if you are eligible.

Note, if you sell your home before the 15 years are over, you owe the remaining balance when you next file.  If, however, you sell your home for a loss, the government eats the remaining balance.  Same thing is true if you die before the 15 years are up.

You: They actually considered my potential death that when writing the law?

I wouldn’t say your death specifically but death in general:  yup

According to the web site Federal Housing Tax Credit, you could save over $8,000 in interest payments compared to likely alternative of financing the full $7,500 over 30 years  One last thing: if you know you’re going to qualify, don’t wait until April to get your money. Adjust your W4 at once or you’ll be giving the government an interest-free loan on the interest-free loan they are trying to give you!

"personal finance"

"financial education"