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REFUNDABLE FIRST-TIME HOME BUYER CREDIT

Key Points

·        The proposal converts the first-time home buyer credit from an interest-free loan to a cash grant in the form of a refundable tax credit of 10 percent of home purchase price, up to a maximum $8,000 credit, for qualifying first-time home buyers who purchase a home between January 1 and November 30, 2009.

·        The provision is likely to speed up some home purchases, providing a very modest temporary boost to the housing market.

·        There is likely to be pressure to extend this provision beyond its scheduled expiration date.

·        JCT estimate that the proposal would cost $6.6 billion over 10 years.

 

Current Law

First-time home buyers are allowed a refundable tax credit equal to the lesser of $7,500 ($3,750 for married-filing-separate returns) or 10 percent of the purchase price of a principal residence. The credit phases out for individual taxpayers with modified adjusted gross income between $75,000 and $95,000 ($150,000 and $170,000 for joint filers). To qualify, the taxpayer must not have owned a home during the three years prior to purchase. In addition, taxpayers are ineligible if they claim the D.C. home buyer credit (a $5,000 nonrefundable tax credit for qualifying purchases in

Washington , D.C. ) or if their home is financed with tax-exempt mortgage revenue bonds (low-interest rate mortgages). 

       The credit is recaptured ratably over 15 years starting in the second year after purchase. That is, the credit is basically an interest-free loan, paid back in installments over 15 years. If the taxpayer sells the home or stops using it as a principal residence, any remaining credit must be repaid. However, the amount repaid is limited to the gain (if any) on sale. (To calculate gain, the taxpayer’s cost basis is reduced by the amount of the credit.) There is no recapture if a taxpayer dies.

The provision applies to purchase between April 9, 2008, and June 30, 2009. Taxpayers who buy a home in 2009 may elect to claim the credit on their 2008 tax returns (with recapture starting in 2010).

 

Proposal

The proposal would increase the maximum credit to $8,000 ($4,000 for married-filing-separate returns), extend the eligibility of the credit through November 2009, and waive the repayment requirement for qualifying homes purchased between January 1 and November 30, 2009, and held for at least three years. Qualifying purchasers in 2009 may elect to claim the credit on their 2008 tax returns.  Effectively, the home buyer credit would be converted from an interest-free loan into a cash grant.  The credit would also be allowed for properties financed with mortgage revenue bonds.

 

Discussion

The proposal would temporarily increase the demand for owner-occupied housing by reducing the after-tax cost for qualifying home purchasers. The higher demand is likely to increase the sale price and shorten the average time on the market of more affordable owner-occupied housing units. That is, part of the benefit of the tax subsidy will accrue to home sellers, especially those with “starter homes.” However, since first-time home buyers are a small part of the housing market, the effect on prices is likely to be very modest. To the extent that the credit encourages people to move from renting to owning, it is likely to also increase rental vacancy rates, depressing slightly the value of rental real estate. Thus, the overall effect of housing prices is likely to be very small. In addition, taxpayers eligible for the credit are likely to buy somewhat better (more expensive) homes than they would without the credit.

The proposal would provide a windfall to qualifying taxpayers who already planned to buy a home and it would encourage some taxpayers who were thinking about buying to speed up their purchases so the sale could be completed by November 30. If taxpayers expect that the credit will expire as scheduled, it would build in an automatic after-tax price increase—offsetting the deflationary expectations in the housing market. Currently, with house prices falling, buyers may perceive that they are better off waiting, which further weakens demand for housing and can lead to further price declines. If the credit expires as scheduled on December 1, home buyers could save $8,000 if they buy before November 30.

While the temporary proposal would have little effect on the housing market, the windfalls to first-time home buyers would provide a modest stimulus. It is not particularly well targeted, but it would be timely. Although the tax credit would be fully refundable, potentially helping households with modest incomes, most low-income people cannot afford to purchase a home (and many would have difficulty finding a mortgage even if they wanted to buy), so the credit would primarily go to middle-income families. The credit could, however, be claimed on 2008 tax returns, meaning that it could raise after-tax incomes fairly quickly if taxpayers either completed their sale before they file or if they chose to file an amended tax return after qualifying for the credit.  There are also programs in place that allow the credit to be used as part of a down-payment on a home through short-term loan programs.  Individuals who purchase their homes using either a HUD-sponsored FHA-insured loan or using mortgages financed by states using tax-exempt debt may be able to monetize the expected credit at the time of purchase using state.

There will likely be pressure on policymakers to extend the scheduled expiration date beyond November 30. Some purchases in the works by November 30 will not be completed in time to qualify and those buyers will lobby for extension. Home sellers, builders, and realtors will also want to extend the expiration date because the real estate market is likely to remain soft for quite some time, and the drop off in demand on December 1 would tend to depress the market again.

As a long-term measure, however, the proposal would increase the tilt in the tax code in favor of owner-occupied housing. Owner-occupied housing is very heavily subsidized, resulting in too much investment in homes and not enough in other productive assets. This is both inefficient and inequitable. (If the cost of a permanent home buyer credit were financed by reductions in other housing tax expenditures, such as the mortgage interest deduction, the proposal could improve equity by retargeting housing subsidies at those with lower incomes and expand homeownership (see Gale et al. 2007).)

However, the credit as modified is much simpler than the original provision. Recapture over 15 years requires fairly extensive record keeping and annual reporting, which, under this proposal, would not be necessary for taxpayers who remain in their homes for at least three years.

 

Grade: C

The proposal would raise incomes of some middle-income families, boosting consumption slightly, and it would be very timely. However, it is likely to do little to solve the housing market’s problems. There is a substantial risk that the credit would be extended, which would be undesirable unless other housing tax subsidies were scaled back.

 

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