At long last, my wife and I finally bought a home.

You: You started looking a year ago, no?

This round, in New Hampshire, yes.  But we also looked to buy a place in Chicago during 1999 and in New Jersey in 2002.

You: So it took you ten years to buy a home?

Sort of.  But we weren’t looking the entire time.  Still, it’s a milestone we’re very much looking forward to enjoying.

You: So what took you so long?

When we almost purchased a condo in Chicago, we were slightly outbid at the last moment.  Then I graduated business school, got married, and took a couple of months off before starting my job.  Honestly, we got distracted and knew we were going to move to New Jersey so we simply stopped looking.

You: What happened in New Jersey?

We planned on renting for a short time while we figured out what neighborhood we’d like to live in.  A bit later we bid on a home and, despite having the highest bid, did not get the home because of some error on the part of the selling agent.  We figured we’d try again – but never did.

You: Why not?

Two reasons.  First, I became exceptionally busy at work and the town we were looking to move to was 45 minutes from where I worked and where I lived.  I simply couldn’t make the time.

You: What was the second reason?

I became very bearish on housing.

You: Really?

Yes.

You: Can you prove it? It’s like your claiming that you predicted today’s stock market activity.

No, I can’t prove it. But it is the truth. Anyway, I was wrong.

You: Wrong?! How so?  Housing prices have plummeted since then.

Prices have plummeted since 2005, yes.  But we were looking during 2002.  So I was a bear a bit early.  Anyway, when we came up to NH in 2005, we also wanted to rent to learn the neighborhoods.  All the while home prices kept falling, albeit slower here than in CA, AZ, NV, and FL.  Also, mortgage rates were low and getting lower so the pressure, financially speaking, wasn’t really on.

You: So what finally got you into a home?

Our desire.

You: Seriously.

Okay, that and the fact that our oldest starts school in the fall and we really wanted her to start with the group of kids she’d be with for a while rather than make her switch at some point. (Of course that’s still possible, but at least it’s not something we’re planning on doing.)

You: So what next?

We had the inspections last week.  We’re signing our names a million times for the mortgage paperwork.  We’ve researched insurance companies and learned a lot about both septic and sewer. Turns out, no one wants our shi– er, stuff we flush.  Lots of details to research and prepare for.  But we’re very excited to close in just foiur weeks.

For those new to our housing search, here are some educational backgrounders:

• Beginning the process of buying a house
• Our debate in looking for a home: Location vs. house
• How and why to choose a buyer’s agent
• Bidding on a house
• Not getting the house
• My thoughts on where is the housing market going

Though my wife and I continue to look for a home, it’s been a while since I blogged about our  housing search. Last year, I shared with you our experiences, including:

• Beginning the process of buying a house
• Our debate in looking for a home: Location vs. house
• How and why to choose a buyer’s agent
• Bidding on a house
• Not getting the house
• My thoughts on where is the housing market going

But since last summer, I’ve written virtually nothing about our home search.  Shortly after not getting the home we bid on last summer*, we got sidetracked.  Life got even busier, we had some big personal stuff to deal with, ya da ya da ya da, so the home search went on the back-burner.

A few weeks ago, we picked up our search in greater earnest.

Some people in the industry assumed that our more deliberate attempt was timed around the impending expiration of the first time home buyer tax credit.

You: Was it?

Now, there are certain elements of my life where I thrive on last minute pressure.  (The best example is my approach to airline travel, where I consider it a failure if I have time to sit in the airport.)  But buying a home?  No last minute pressure needed.

Instead, we have the self-imposed deadline of moving into a home before the next school year begins, as our oldest daughter is about to begin kindergarten and we’d just as soon not have to move her shortly after she begins her formal schooling.

You: Can you really call kindergarten formal schooling?

I wasn’t sure what else to call it.

You: Can’t you just call it kindergarten?

Yes, but then the sentence would have had two kindergarten’s in it.

You: So?

You’re right. She’ll start kindergarten next year.  Jeez.

Anyway, the first time home buyer tax credit would be worth $8,000 to my wife and I, so it’s not to be discarded. In fact, we’re still hoping to take advantage.

You: You’d have to move fast.

Yes, we’d have to come under agreement by Friday and close within two months.  If it happens, great, but if not, the world continues.

You: How could you be so cavalier about $8,000?  You’re a financial educator!

It’s not that I wouldn’t like $8,000. Heck, I’d love $8,000. It’s just that you have to think about it in the context of other things.

You: Well, to me, the context is either you get eight grand or you don’t get eight grand.  If it were me, I’d choose the option where I get the eight grand. What larger context are you thinking about?

What the market might look like after April 30.

You: What do you mean?

Anecdotally, the looming expiration of the home buyer credit is pushing sales forward into April. People who might not buy (or sell for that matter) for another month or two are rushing to get their deals done this month.  For them, the credit is a much bigger opportunity.

You: Why is it a bigger consideration to them than it is to you?

For better or worse, low down-payment and FHA loans are still very common.  This means that a buyer purchasing a $200,000 home might only have to write a check for about $6,000. Maybe $10,000.  If the buyer qualifies for the credit, the net amount of their own money they have to put into the home is negligible.  It’s like getting a home with no money down.

You:That doesn’t sound good.

I agree. In fact, that was part of the problem causing the housing correction in the first place, though there were definitely other factors involved.

On the other hand, my wife and I, along with numerous others trying to be fiscally responsible when buying a home, will put down 20% or more of the home purchase price. Such a move means the avoidance of primary mortgage insurance (PMI) a significant cost that provides you no upside (any insurance benefit goes to the bank; but the premium cost is paid by you).  As such, we’ll be handing over a rather large check when we close. Yes, it would be nice to have $8,000 come back to us several weeks later in the form of a credit, but if we don’t get it, life will go on.

We’re hoping to find the right home in the next two days, but if we don’t, I’m confident we’ll be one of the few couples shopping in May and June. That will give us leverage in any future negotiation process. It wouldn’t surprise me at all if that future supply/demand imbalance gets us an additional concession greater than the $8,000 we lost by not coming to an agreement this week.  In our case, if the home price goes down by $10,000, we’re writing a check for $10,000 less.  Since $10,000 is greater than $8,000, we win.

The only thing we’re trying to avoid is purchasing a home next week that we could have purchased (at about the same price) this week.

I’ll keep you posted (more frequently than the last few months, too).

Who has thoughts on this?

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*By the way, remember the home we didn’t get last year because we were outbid? Just learned yesterday that neither did anyone else. Turns out the sellers backed out at the last minute and decided to stay put.  Now I’m kind of glad we weren’t the ones who had their dreams crushed at the last minute.  (Better not to get your hopes up so high in the first place, but I imagine it would be hard to avoid seeing yourself in the home after you have a contract in place. Nonetheless, my lesson is to do my best not to get too overjoyed until someone hands me keys.)

Although Friday comes every week, Friday Q &A comes around only when someone submits a good question AND I have time to answer it.   Both happened this week, so here we go. Want to ask a question?  Click here for more information or simply email a question.

I plan on buying a  home from my parents that wasn’t their primary residence, it is a rental property. I understand that I wouldn’t be able to get the $8,000 credit because my parents owned the home. What if an unrelated person bought the home from my parents but doesn’t qualify for the First Time Home Buyer Credit, and then I purchased the home from them later to get the $8,000? Is there any restrictions on trying to get the credit this roundabout way?

Thanks,

Paul

Straightforward Answer: Sounds like fraud.

Detailed Explanation:

As you are aware, any home purchased from a close relative, a definiiton that includes a parent, disqualifies you from the first time home buyer tax credit.  Technically, what you are saying – have a parent sell it to someone else and then you buy it from that person – is possible.  There’s nothing remotely illegal about it. But if it’s done solely to get the credit?  Doesn’t pass the smell test?

Transactions that are entered into solely for the purpose of tax avoidance aren’t well-received by the IRS.  Surely, that won’t really surprise anyone. For tax geeks:

Transactions entered into solely for the purpose of tax avoidance, which lack any business purpose, are shams and without effect for Federal income tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561 (1978); Knetsch v. United States, 364 U.S. 361 (1960). The leading case supporting the existence of a “sham transaction doctrine” is Gregory v. Helvering , 293 U.S. 465 (1935).

Furthermore, calculate the transaction costs – real estate commissions, recording fees, etc.  My guess such expenses will cost more than $8,000.  So don’t bother. Want the credit?  Buy a different house. Or buy your folks’ home and forget about the $8,000.

FYI, there are over a thousand comments on my other first time home buyer tax credit posts, many of them are of a Q & A nature.  You can check them out here:

• First Time Home Buyer Tax Credit – 2009 Version
• First Time Home Buyer Tax Credit: When a credit isn’t a credit but it’s still free money
• First Time Home Buyer Credit – Your options if you buy after April 15

Saving for a home or, more precisely, how to save for a home is today’s Q & A.

You: Q & A?

Although Friday comes every week, Friday Q &A comes around only when someone submits a good question AND I have time to answer it.   Both happened this week, so here we go. Want to ask a question?  Click here for more information or simply email a question.

I would like to know what is the most effective way to save for a home? I am currently putting the matching percentage of my employer into my 401(k). Should I open an IRA account or Money Market account to reach my goal of 20% down payment on a home?

I believe my income prevents me from getting a ROTH IRA but I am not sure about a traditional IRA.

Matt C.

I love when people ask questions like Matt’s, because it shows they’re committed to doing the right thing and simply want advice as to the best way to do it.  Contrast Matt’s question with the infinitely more common, “Can I use my emergency fund  (It’s almost $1,000!) to make a down-payment on this new car I want? I’d be getting a great deal!”

For anyone that has a matching program at work, taking advantage of said program is step # 1. Matt’s done that – congrats to him.

Now, Matt wants to know how to save for a home – an appropriate goal for most individuals.  Have you paid off your high interest credit card debts?  Do you have an emergency fund?  If so, great. If not, go there first – those items are more important than the house.  Seriously.

Once you’re ready to save for the home, I believe it makes sense to open a separate account (it can be at the same institution where you already have a relationship) that is earmarked for that purpose.  Doing so makes it much more difficult for you to take the money out for some alternative purpose in the many months (possibly years) before you actually take the plunge into homeownership.

While others will argue that an IRA or a Roth IRA (each of which has some exceptions to taxes and penalties due on a pre-retirement distribution when the money is used to buy a home), I do not support this approach.  Rather, create a regular taxable savings or money market account.  The tax savings, particularly in this pathetic interest rate environment, from using a retirement account to save for a home will be negligible at best. More importantly, I prefer to think as retirement plans as exclusively available for retirement. If you tolerate one exception, why not another later on?

A retirement plan is to used for retirement.  Keep your promise. It’s a promise you’re making to yourself, anyway!

How to Save for a Home – Account Specifications

Don’t put your money in an account that is not FDIC insured. Right now, there’s a $250,000 limit on insurance per account.  There’s no reason to take on any risk with your down payment money.

Choose a bank that pays some freaking interest. While interest rates for savers are disappointing almost everywhere, there is still a meaningful spread between the least and most generous banks, a range that is likely to become more important when rates one day increase across the board.  Internet only banks like ING DIRECT, HSBC, Emigrant Direct and others are great places to start. Bankrate.com lists the highest paying institutions.

Consider CDs.  If you know you’re not going to buy a house for 6 months, a year, or even longer, consider CDs as a way to earn a bit more interest. I don’t suggest going too long, however, as you may not want to lock in your rate for, say five years at a couple of points, since rates may be much higher before your term is done.

Establish a realistic goal. Then achieve it. Do what you can to get a down payment of 20% of your purchase price, saving you the potential significant expense of mortgage insurance.  (Matt’s 20% wasn’t picked out of thin air.  It’s the goal all first time home owners should set for themselves).  If 20% sounds like a ton of money, it probably is.  But you’ll be more financial savvy for achieving that amount, as many home owners (and former home owners) have recently discovered. Banks too have re-learned the importance of a home owner have a financial stake in their home.

Good luck Matt. Stay in touch and let us know what you decide to do.

#     #     #

Anyone else planning on buying a home soon?  My wife and I still are, although we haven’t updated you on our progress (or lack thereof) recently.  More to come.

Due to the Worker, Homeownership and Business Assistance Act of 2009 signed into law on Nov. 6, 2009, the rules surrounding the first time home buyer tax credit have changed again. However, these rules only apply to homes purchased after November 6, 2009.

You: What if I  purchased a home before November 6, 2009?

When did you buy it?

You: Between January 1, 2009 and November 6, 2009.

Then you might qualify for the 2009 version of the first time home buyer tax credit.

You: What about my friend who purchased a home after April 9, 2008 and the end of 2008?

Your friend could qualify for the 2008 version of the first time home buyer tax credit.

You: And what about the folks who purchased their home before April 9, 2008?

They get nothing.

You: Nothing?

Unless they purchased their home before June 30, 2005.  Then, they might qualify for the enhanced credit just signed into law.

You: Really?

Really.

You: So there’s potentially something for everyone with this credit.

Except those who purchased their homes between June 30, 2005 and April 9, 2008.

You: What’s the government got against those folks?

Nothing, best I can see.

You: But they’ll be upset, don’t you think?

I do.  Ironically, these are the people most likely to be upside-down (owe more than they’re worth) on their homes.

So I’ve opened the can of worms. Feel free to dive in below.

On November 6, the first time home buyer tax credit was enhanced and updated.  Here are the changes to the 2009 version of the first time home buyer tax credit resulting from the new legislation:

• Deadline extended: Now you have until April 30, 2010 to establish a contract to purchase a home and June 30, 2010 to close on that home in order to receive the credit.
• Income limits increased: The phaseout of the credit does not begin until incomes reach $125,000 (single) and $225,000 (married filing jointly).
• Maximum price established: The credit is not available for homes which sell for more than $800,000.

Other key considerations remain the same:

• Credit value unchanged: $8,000 or 10% of the purchase price, whichever is lower.
• Pick your favorite tax return: You can file for the credit in either the year of sale of the prior year.  (For example, if you buy a home on November 30, 2009, you can file for the credit on your 2009 or 2008 return. If you buy a home on April 3, 2010, you can file on your 2009 or 2010 return.)
• Still not for flippers: You have to own the home and use it as your principal residence for at least three years or you will forfeit the credit.

But wait, there’s more:  the first time home buyer tax credit isn’t just first time home buyers anymore! The new law establishes a credit for people who have owned a home for at least five years.  If you’ve owned a home for four years and want to take advantage of the credit, sorry, but there is no credit for you. In your comments below, please remember that I am only the messenger.

Key Points on the Not a First Time Home Buyer Tax Credit (Replacement House Credit):

• Better not have just got there: You must have lived in a home you own for at least five straight of the previous eight years.
• Lower credit: Only $6,500 for this credit.

All the other key points, including the need to own your next home for at least three years, income restrictions, expiration date, and filing requirements are the same as they are for the first time home buyer tax credit.

If you purchased your home during 2009 but before November 6, 2009, read about the 2009 version of the  first time home buyer tax credit.

If you purchased your home during 2008 and after April 9, 2008, read about the 2008 version of the first time home buyer tax credit.

If you purchased your home after June 30, 2005 and before April 10, 2008 and want to know why you get nothing, not even the chance to take part in the new part of the credit, read this article where you can gather precious little insight as to the government’s thinking. However, it’s a good place to vent.

Within my post last week titled First time home buyer tax credit may actually expire, I maintained my steadfast belief that Congress and President Obama would not allow the credit to end.  Simply stated, I argued, the housing market is still so unstable that taking away stimulus was unlikely.  (Furthermore, it’s far easier for the government  to defend stimulating a market even if things take off than to defend passing on a stimulus package should things crash.)

Nonetheless, there was serious talk last week about letting the credit expire.

Just a few days later, the President has officially weighed in on the side of extending the credit.

Now my confidence level in the extension is at about 99%.

You: What will change as a result of the credit extension?

Nothing is certain given the ongoing negotations between Republicans and Democrats, particularly in the Senate.  Nontheless, here are the key provisions likley to be impacted:

Delayed Expiration Date

To qualify under today’s laws, you must close on your house by November 30, 2009.  The most likely outcome of the current legislation is a requirement that you are under contract by April 30, 2010 and that you close within 60 days.

Higher Income Limitations

Rather than phaseouts beginning at $75K and $150K (single and married, respectively), the new ranges would begin at $125K and $225

Maximum Home Price

Today, there is no limit on the price of the home purchased to qualify for the credit.  Congress is mulling over an $800,000 limitation going forward.

Possible Expansion to Existing Home Owners

Congress is considering allowing those who have lived in their homes five years or longer the ability to qualify for a smaller credit.  Expect significant complaining by those who purchased their homes in late 2005 who would just miss out if this provision passes.

None of the above should be considered final because the bill hasn’t passed yet and negotiations are ongoing.  They’re expecting to vote next week. Stay tuned, I’ll keep you posted.

What do you think of this possible legislation?

The first time home buyer tax credit is currently set to expire on November 30, 2009.  As the law currently stands, only homes purchases with a closing date before the end of November will qualify for the $8,000 credit.

I have said, numerous times, that I believe the credit will be extended.

You: Why? Who do you know?

I don’t know anybody with influence in Washington, but logic says the credit will be extended.

You: Explain this logic.

Many experts believe that the credit itself, combined with the aggressive actions of the Federal Reserve and Treasury Department (by effectively and dramatically lowering mortgage interest rates), has created an artifical bottom in the market.  Despite this, an incredible percentage of homeowners remain under water.

You: What exactly does “under water” mean?

That they owe more on their homes than their homes are worth.  Furthermore, foreclosures are at record highs and inventories are still high by historic standards.  While some areas of the country have clearly stabilized, others have not.

I have always thought that the government would be extremely averse to removing stimulus from the housing market until it was self-evident it could stand on its own.  The housing market does not appear capable of doing so today.

You: Why do you say so?

In my experience looking for a home in a market (southern New Hampshire) this year, a market most characterize as relatively stable, I have been very impressed by how little activity has taken place in the mid-market.

You: Mid-market?

Meaning homes priced beyond typical starter homes but for far less than anything considered luxury.  In other words, solidly middle class homes simply aren’t moving because buyers and sellers have very different opinions about what homes are currently worth.  As such, many very nice homes have been on the market for over a year.

That’s evidence that the market is not working normally.

For all of these reasons, I continue to expect the credit to be extended. But remember I leave in the real world, not Washington.  In our nation’s capitol, as Ilyce Glink reports, $8,000 Tax Credit Extension? White House Says Maybe.

Stay tuned.

It’s Friday, so it’s time for this week’s reader-submitted Q & A. (Two covered this week – I am so motivated!)  If you’d like to submit a question, click here for more information or simply email a question.

I purchased a mobile home over 17 years ago for cash and have been paying rent for a space in a trailer park.  Am I considered a home-buyer so am ineligible for the tax incentive?  I am in the process of buying a condo along with a non-relative and she is not eligible for the it.

- Phyllis

Straightforward Answer:  Probably not.

More Detailed Explanation

As I wrote recently on my post First Time Home Buyer Tax Credit – 2009 Version (a post with over 500 comments on it):

For anyone who owns a trailer home, mobile home, or lives in an RV and has been asking or wondering about if they’ll qualify for the first time home buyer tax credit if they purchase a home that is permanently fixed to the land: I just found this link at the IRS web site which seems to suggest that those currently living in RVs will qualify (and presumably, as I have suggested, those living in mobile homes and trailer homes without motors will not.)

Here is the relevant Q & A excerpted:

Q. Can an individual who has lived in an RV qualify for the credit?

A. For purposes of the first-time homebuyer credit, an RV with a built-in motor is personal property that is not affixed to land and does not qualify as a principal residence. Accordingly, someone who has owned and lived in an RV within the past three years may still qualify as a first-time homebuyer.

If we have a purchase agreement signed but we don’t end up closing on the house until after Dec.1,2009 will we still be able to collect the $8,000.00?

- Chenoa B.

Straightforward Answer: Nope.

More Detailed Explanation

You must close before 12/1/09.  (Unless Congress extends the deadline. While I personally believe some form of the credit for the period starting 12/1 will be passed, there can be no assurance and no vote is on the horizon).

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I purchased a home in Nov. of 2008 for $200,000. In July of 2009 I sold it for $265,000. If I am using all of the proceeds from the sale to pay for my new house, will I still have to pay capital gains tax on the profits because I did not live in the house for two years? What rate would the tax on the profits be?

-Rene M., Ventura, CA

Straightforward Answer:  You probably won’t have to pay any capital gains taxes, but not for the reason you think.

More Detailed Explanation

Back in 1997, Congress changed the rules governing the taxation of a gain realized on the sale of a personal residence. Until that time, you could defer your gain (and not pay any capital gains taxes) on your residence as long as you used the proceeds of the home you sold to buy a home that was, roughly speaking, at least as expensive as the home you sold.  I think that may be why Rene mentioned “using all of the proceeds from the sale to pay for my new house.”

Today, that fact is meaningless.  Since 1997, new laws have governed what you can exclude (not just simply defer) from tax as a result of selling your personal residence at a gain.  (Admittedly, there have been a lot less questions about this since the housing crisis began, but it appears something went well for Rene.)  Now, you can exclude up to $250,000 of gain ($500,000 if you’re married) permanently.  The most important criteria to qualify are that you must own and live in the home for at least two of the five previous years before the sale date.  That’s where Rene ran into a problem,  since she only owned the property for about eight months.

If Rene sold her home due to a job change, declining health, or other unforeseen circumstances (as outlined by the IRS), then she may qualify for a reduced exclusion. If she just didn’t like her home anymore and wanted to go across the street, she won’t.  She’d owe tax on her gain of approximately $65,000. Her rate would be the short-term capital gains rate, which is the same as her ordinary tax rate (based on her income).  The preferable lower capital gains tax rates are only applicable for assets held more than one year.

Assuming Renee qualifies for one of the stated reasons, however, her reduced maximum exclusion would be eight divided by 24 (eight months representing the time she actually did own the home,  24  being the number of months she would have had to own the home to get the maximum exclusion). Assuming Rene is unmarried, 8/24 is then multiplied by $250,000. The result is $83,333, which exceeds the $65,000 gross profit on the home.  As such, it’s unlikely she’ll owe capital gains taxes.

Please note that there are some intricacies to the tax law on which I have not gone into great detail (see aforementioned housing crisis for reasons why I’ve decided to spend my time educating you elsewhere at the moment).  For example, less than the full $65,000 might have been taxable had Rene, for example, added a bedroom during the eight months she owned the home. Such details are why, when you have a big event in your life, it’s worth considering hiring a professional tax-preparer.