Practice Alert
Despite improvement in some areas, it's still the worst of times for many homesellers, particularly those who bought near the peak of the market. Thanks to dramatic drops in selling prices, it's also the best of times for those looking to become homebuyers, particularly those who can turn to well-off parents or grandparents for financial assistance. This Practice Alert surveys why it's a good time, taxwise, to buy a home, and a good time, taxwise, to help make homeownership a reality for children or grandchildren.
First-time homebuyer credit. Individuals who become first-time homebuyers in 2009 are entitled to a refundable tax credit if they make their move before Dec. 1, 2009. The refundable tax credit (claimed on Form 5405) is equal to the lesser of 10% of the purchase price of a principal residence or $8,000. (Code Sec. 36)
A taxpayer is a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the 3-year period before the purchase of the home to which the credit applies. (Code Sec. 36(c)(1)) IRS guidance states that a taxpayer who owns a property formerly used as their residence that's been rented out for the past three years may qualify for the credit.
Any home purchase (including, presumably, coops and condos) qualifies but only if (1) the property isn't acquired from a person related to the buyer (under detailed rules in Code Sec. 36(c)(5)); and (2) the basis of the property in the hands of the buyer is not determined by reference to the adjusted basis of the property in the hands of the person from whom it was acquired, or under Code Sec. 1014(a) (property acquired from a decedent). (Code Sec. 36(c)(3)) A home under construction by a taxpayer is treated as purchased by him on the date he first occupies it. (Code Sec. 36(c)(3)(B))
No credit is allowed if: (a) the taxpayer disposes of the home (or it ceases to be a principal residence) before the close of a tax year for which a credit otherwise would be allowable; (b) the taxpayer is a nonresident alien; (c) the taxpayer's financing is from the proceeds of tax-exempt mortgage revenue bonds; or (d) the D.C. homebuyer credit is allowable for the tax year the residence is bought. (Code Sec. 36(d))
The homebuyer credit phases out for taxpayers with modified adjusted gross income (MAGI) between $75,000 and $95,000 ($150,000-$170,000 for joint filers) for the year of purchase. MAGI is AGI for the tax year increased by any amount excluded under Code Sec. 911 (foreign earned income and foreign housing exclusions), Code Sec. 931 (income derived from American Samoa) or Code Sec. 933 (income from Puerto Rico). (Code Sec. 36(b)(2))
If the credit is claimed on a principal residence purchased in 2009, the credit is recaptured if the home ceases to be the taxpayer's principal residence within 36 months from the date of purchase. (Code Sec. 36(f)(4)(D)(ii))
Eligible first-time homebuyers who purchase a principal residence after Dec. 31, 2008, and before Dec. 1, 2009, may elect on an amended return to treat the purchase as made on Dec. 31, 2008. (Code Sec. 36(g))
RIA observation: The election effectively allows eligible first-time homebuyers who make a timely purchase in 2009 to put the $8,000 credit in their pockets quickly, instead of having to wait until they file their 2009 returns.
RIA observation: To help buyers that need downpayment and closing cost assistance when buying a home eligible for the first time homebuyer tax credit, a number of state housing finance agencies are offering special short-term second loans to qualified buyers. These loans carry little or no interest and may be repaid with the homebuyer tax credit refund. For details, and which states are participating, go to http://www.ncsha.org/section.cfm/3/34/2920 .
Other tax benefits produced by first time homeownership. Often, first time homeowners also will become a first time itemizers due to the deductions for interest and property taxes, enabling them to deduct expenses (e.g., medical, charitable, miscellaneous itemized deductions) they couldn't claim before.
RIA observation: Buying a first-time home late in the year may only yield a small amount of taxes and mortgage interest paid for 2009 (unless the buyer pays a substantial amount for “points”), and, as a result, the purchaser may wind up claiming the standard deduction in 2009 before he becomes an itemizer in 2010. The home purchase can help in this situation, too. For 2009, taxpayers who claim the standard deduction instead of itemizing deductions may under Code Sec. 63(c)(7) claim an additional standard deduction for State and local property taxes paid. The deduction can't exceed the lesser of State and local property taxes actually paid or $500 ($1,000 for joint return filers). Taxes taken into account in arriving at adjusted gross income under Code Sec. 62(a) (i.e., taxes deducted as trade or business expenses in computing the taxpayer's adjusted gross income) aren't taken into account in computing the additional standard deduction for property tax.
Tax benefits in helping kids become homeowners. Those able to help their children or grandchildren become first-time homeowners can do so in a number of tax-wise ways:
Make cash gifts. The annual per-donee gift tax exclusion ($13,000 for 2009), makes it possible for parents to give children major assistance with the downpayment for a home purchase. Each parent can give $13,000 to the child, for a total of $26,000, and if the child is married, each parent can do the same with the son- or daughter-in-law, for a total gift-tax-free amount of $52,000 (grandparents also can chip in).
RIA observation: Gifts excludible under the annual exclusion are advantageous from an estate tax point of view. Though not subject to gift tax, they are excludible from the donor's gross estate and therefore also escape estate tax and/or generation skipping transfer (GST) tax. And because excludible gifts aren't included in “adjusted taxable gifts” (a decedent's post-'76 taxable gifts within the meaning of Code Sec. 2503, namely total gifts less certain deductions and exclusions, other than gifts includible in the decedent's gross estate), they aren't added to the donor's taxable estate for purposes of computing the estate tax and so they don't push the taxable estate into higher brackets as taxable gifts do.
Make gifts of appreciated assets. Instead of making a cash gift to help with the downpayment, a parent or grandparent may consider gifting appreciated stock, mutual-fund shares, and other securities that have been held for more than one year to their children if the latter are lower-bracket taxpayers. The children can then sell the securities. This turns a gain that would be taxed at 15% if the parents sold the securities into a tax-free gain.
Reason: The holding period for property acquired by gift includes the donor's holding period if the property has the same basis for gain or loss in whole or in part in the hands of the donee as it would have in the donor's hands. (Code Sec. 1223(2); Reg. § 1.1223-1(b)) And under Code Sec. 1(h), a zero tax rate applies to most long-term capital gain (as well as dividend) income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate.
To avoid transfer tax consequences, the value of the gift of appreciated securities shouldn't exceed the annual exclusion.
Make a low-interest loan. A parent can consider giving a child a loan (instead of, or in addition to, a gift of cash or securities) to make first-time homeownership possible.
The loan can cause complex imputed interest problems under Code Sec. 7872 if it's a “below market interest” loan. If a below-market (or interest-free) loan is a “gift loan” (that is, a below-market loan where the forgoing of interest is in the nature of a gift) that exceeds $10,000, it's treated as: (1) a loan to the borrower/donee in exchange for an interest-paying note, and (2) a gift to the borrower of the funds to pay the interest. The amount of the gift equals: the forgone interest—excess of interest payable at the applicable federal rate (AFR) over actual interest payable—if the loan is a demand loan (i.e., one payable on demand); or the excess of the amount loaned over the present value (using a discount rate equal to the AFR) of all payments required under the terms of the loan, if the gift loan is a term loan. (Code Sec. 7872)
However, a parent can avoid all of these problems—and still give the child a major break—by charging the child interest at the appropriate AFR, which is very, very low these days. For example, for loans made in September, the short-term AFR (term loans with a term not exceeding three years) is .84%, the mid-term AFR (term loans over three years but not over nine years) is 2.83%, and the long-term AFR (term loans over nine years) is 4.29% (all rates for a monthly period of compounding). (See AFR Rates for September 2009 in yesterday's Newsstand e-mail.)
Source: Federal Tax Updates on Checkpoint Newsstand tab 8/20/09
