One of the defining characteristics of the American tax code is that it is used for more than merely raising government revenue. Instead, the progressive tax system is also used to encourage behavior deemed socially beneficial, discourage behavior considered socially undesirable and to remedy or relieve temporary economic difficulties. The homebuyer tax credits fall into the latter category, being specifically designed to help ease the collapse of the real estate market that began in late 2007 and has continued ever since. The basic idea was to use the tax code in order to provide prospective homebuyers with a good incentive to buy new homes despite the collapse of the residential real estate market.

The first measure was passed in 2008 in the form of the Housing and Economic Recovery Act, which offered a tax credit of up to $7,500 for first time homebuyers. The tax credit was not an actual grant of money, but instead operated like an interest-free loan that would have to be repaid through the tax system gradually over the subsequent fifteen years. This original plan only applied to homes purchased between April 8, 2008 and January 1, 2009 and had to be claimed by filing the new Form 5405 that was created specifically for this purpose. The problem was that during the period covered by this law, residential real estate markets were in free fall all across the country with properties losing value on a monthly basis. Further, in the wake of the subprime mortgage crisis, most lenders tightened up their lending standards dramatically resulting in the credit crunch. The result was that this initial measure only met with limited success.

The limited success of this original plan resulted in it being substantially expanded through the Worker, Homeownership and Business Assistance Act of 2009. This act expanded the time frame (up through April of 2010), increased the credit amounts, and – perhaps most importantly – extended the tax credit to people that already owned homes, removing the “first time” requirement that was part of the original measure. This extension of the plan to people that already owned homes was essential to the measure’s success since by the latter part of 2008 the only people that had enough collateral and good enough credit to get a new mortgage loan were the same that had already owned homes and had equity in them.

As is the case with most tax credits and other incentive programs administered through the tax code, there are a number of conditions that have to be met in order to qualify. For example, the property in question has to be the taxpayer’s primary residence, so people buying rental properties cannot claim the credit. All the specific details can be found by looking for the “First-time Homebuyer’s Credit” on the IRS website: www.irs.gov.

The substantial amount of the tax credit, despite the fact that it has to be paid back, has made the measure very popular and some lenders will even accept the credit as a down payment of the new mortgage. Further, since the time period has been expanded, most housing markets have already bottomed out, meaning that buyers are much more willing to buy new homes. Finally, the credit crunch is also starting to relax some, meaning that mortgages are gradually getting easier to get. The result is that the extended and improved tax credit is likely to be much more successful than the 2008 measure.

Have a tax question? Ask one of our tax professionals.