Can a home buyer qualify for the first-time homebuyer tax credit if they are buying on a land contract (aka agreement for sale, contract for deed)?

When a home buyer purchases a home with seller financing, through an installment sale, using an agreement for sale (also known as a "contract for deed" or "land contract"), the seller generally retains legal title, while the buyer gets "equitable title". The buyer has equitable title because the agreement for sale gives them a claim on the title, and the agreement for sale or equivalent is generally recorded in the public record, to prove that the buyer has equitable title. But the buyer doesn't get full legal title until they pay off the loan to the seller.

There was a big question about whether the buyer would qualify for the first-time homebuyer tax credit, since they weren't getting legal title at the time of the purchase. I called the IRS and asked them about it, around April 2009, and the person I talked to seemed pretty clueless, but her opinion was that the buyer would probably NOT be eligible for the tax credit. But a lot of people must have put that same question to the IRS, because on July 2, 2009, they updated the FAQs regarding the tax credit.

And good news, the answer is YES, the homebuyer does qualify for the tax credit, as long as the agreement meets certain requirements. Here's what they said exactly (from this link on the IRS site):

Q. Can a taxpayer claim the first-time homebuyer credit if the purchase is pursuant to a seller financing arrangement (for example, a contract for deed, installment land sale contract, or long-term land contract), and the seller retains legal title to secure the taxpayer's payment obligations?

A. If the taxpayer obtains the "benefits and burdens" of ownership of a residence in a seller financing arrangement, then the taxpayer can claim the credit even though the seller retains legal title. Factors that indicate that a taxpayer has the benefits and burdens of ownership include: 1. the right of possession, 2. the right to obtain legal title upon full payment of the purchase price, 3. the right to construct improvements, 4. the obligation to pay property taxes, 5. the risk of loss, 6. the responsibility to insure the property and 7. the duty to maintain the property. (New 7/2/09)

Investors no longer protected under Arizona Deficiency Judgment Statute?

In Arizona, home owners that have their home foreclosed are exempt from deficiency judgments if their property is under 2.5 acres and consists 1 or 2 units. Previously, that included owner occupants, investors, and even developers. However, a recent bill appears to make it so investors are no longer included.

From Tom Farley, Arizona Association of Realtors, July 16, 2009:

"SB 1271 - Anti-Deficiency Law Change

One of over 200 bills pushed through the legislature in less than a month was a big change to an existing law that provided protection to borrowers in some cases against a deficiency judgment when their property went through foreclosure. Below is some background information on the legislation that has the lending and real estate industries a buzz with its intended and unintended consequences.

SB 1271 - Serious Changes to Arizona's Anti-Deficiency Statute

SB 1271 was sponsored by Senator Sylvia Allen, a REALTOR® from the White Mountains area of our state. The legislation started out in January as a bill dealing with jail districts and property tax limits. In June a strike-everything amendment gutted the original bill and changed its direction entirely. The Arizona Bankers Association argued successfully that the changes provided in the legislation were necessary because abuses in the current law were costing Arizona-based banks millions in losses. There was significant sympathy for the Arizona community banks in making the changes provided by this legislation. In other words, the legislators found it very easy to hold property investors liable for their debts while arguing that homeowners would still retain their deficiency protection if they lived in the home for six consecutive months. The legislation sailed out of the Senate by a unanimous vote but just barely received enough votes to pass the Arizona House of Representatives. The Governor signed the bill on the last day to sign or veto the legislation.

The current law - Arizona Revised Statutes (A.R.S.) § 33-814 currently states that within 90 days after the date of sale of a trust property under a trust deed, a legal action may be brought to recover a deficiency judgment against the borrower (trustor) who has now had their property foreclosed. The deficiency judgment must be for an amount equal to the sum of the total amount owed as of the date of the sale either by the fair market value of the trust property as determined by the court or the sale price at the trustee's sale, whichever is higher. The current law prohibits a lender from seeking a deficiency judgment against the trustor (foreclosed property owner) if the trust property is 2.5 acres or less and is used as a single one-family or single two-family dwelling.

The law effective September 30, 2009 - SB 1271 amended A.R.S. § 33-814 (G) to require that the trustor must have "utilized" the property for six consecutive months and a certificate of occupancy must have been issued. What does this likely mean? Various attorneys are opining different theories. My interpretation of the statute is that after September 30, 2009, properties sold at trustee's sale likely will not qualify for the anti-deficiency exemption unless the trustor lived in the single one-family or single two-family dwelling for at least six consecutive months. The legislative Fact Sheet, as transmitted to the Governor, states that SB 1271:

Prohibits a deficiency judgment against a trustor pursuant to a trustee's sale of a trust property that is 2.5 acres or less and is used as a single one-family or single two-family dwelling if both of the following apply:

* The trustor has lived in the trust property for at least six consecutive months.
* A certificate of occupancy has been issued for the property.

Places the burden of proof on the trustor to demonstrate that the statutory requirements to prohibit a deficiency judgment are met.

As before this law was passed, REALTORS® should advise their clients to consult legal counsel regarding the application of the anti-deficiency statute."

There is a good explanation here about deficiency judgments, from before this new statute was passed.

How to Amend Your Tax Return to Claim the First Time Home Buyer Tax Credit

If you purchase a home before December 1, 2009, for purposes of the first time homebuyer tax credit, you can treat the purchase as if it had happened on December 31, 2008. So you can claim the tax credit on your 2008 return by filing an amended return for 2008.

For the amended return, the 2 forms you need to file are:

1. The Amended U.S. Individual Income Tax Return (Form 1040X)
   
2. The First-Time Homebuyer Credit (Form 5405)
   

Additional info from the IRS page about amended returns:

• If you are filing to claim an additional refund, wait until you have received your original refund (you may cash that check).
  
• When filing the amended return, attach copies of any forms or schedules that are being changed as a result of the amendment including any Form(s) W-2 received after the original return was filed.
  
• Tax forms can be obtained by calling 800–829–3676 or visiting www.irs.gov
  
• Normal processing time for Forms 1040X is 8 to 12 weeks from the IRS receipt date.
  

What is my Tax Basis?

The tax basis (or "cost basis") of your home is the amount the IRS thinks that your home is worth. It is not related to the actual market value.

Your tax basis is used to calculate capital gains. For example, if you sell a home for $120,000, and your tax basis is $101,000, then you have a $19,000 capital gain.

Your tax basis is determined by taking the original purchase price, adding in the capital improvements that you have made to the property, and subtracting depreciation deductions.

Capital improvements are improvements that you make to the property that last a long time. For example, putting a new roof on your house is a capital improvement.

Property expenses on investment property can be deducted on your taxes right away. But capital improvements cannot be fully deducted on your taxes in the year of the expense, rather, they are "capitalized", or deducted over the life of the improvement. (Short term expenses, such as paying someone to mow the lawn, can be "expensed", or deducted fully on your taxes in the same year as the expense was paid, so they do not increase your tax basis.)

Depreciation is a tax deduction that you can take each year based on the assumption that as a property ages, it goes down in value, or "depreciates". This assumption is valid for a computer, but generally not valid for a home. (Homes generally go UP in value even though they are getting older.) That is why depreciation is referred to as a "paper loss", because it is a loss "on paper", but not an actual loss of value to the property.

The IRS determines the life span of a residential home to be 27.5 years, so each year you can deduct 1/27.5th of the property value, not including the land value. For example, if you bought a property for $100,000 and determined that the land was worth $15,000, then you could deduct approximately $3,090 each year for the next 27.5 years. (To get that value, I took $100,000 - $15,000 = $85,000 which represents the value of the building, or "improvement", then divided $85,000 by 27.5 to get $3,090.) (NOTE: Even if you don't deduct the depreciation amount on your taxes, your tax basis is still reduced by that amount!)

The amount of depreciation that you can take in the year of the purchase is determined by the month of the purchase. For example if you bought in the middle of the year, you would get about half of the yearly depreciation amount. The IRS provides tables to determine the depreciation amounts in the year of the purchase (acquisition) and in the year of the sale (disposition).

Simplified Example:

1. You bought a property for $100,000.
   Tax basis at that time: $100,000
   
2. You put a new roof on the house for $10,000.
   Tax basis at that time: $100,000 + $10,000 = $110,000
   
3. You deducted $3,000 per year in depreciation for 3 years, for a total of $9,000 in depreciation deductions.
   Tax basis at that time: $110,000 - $9,000 = $101,000
   
4. You sold the property for $120,000. You had a capital gain of $19,000. Since you held the property longer than 1 year, you would pay capital gains tax at long term capital gains rates, which is currently 15%, (although it could go up at any time), so your tax bill would be $19,000 x 15% = $2,850.
   

Details of the $8,000 tax credit for first time home buyers

The American Recovery and Reinvestment Act was passed on February 13th, 2009. Among other things, the Act allows for an $8,000 tax credit to first time home buyers.

Prior to the American Recovery and Reinvestment Act of 2009, there was already a first time home buyer tax credit in place, of $7,500, but the big difference is that the $8,000 does not have to be paid back! For first time home buyers who bought their home between April 9, 2008 and December 31st, 2008, the first time home buyer tax credit of $7,500 has to be paid back over 15 years, or when they sell the home.

Here are the details of the $8,000 first time home buyer tax credit as determined by the American Recovery and Reinvestment Act of 2009:

• The $8000 tax credit is available only to first time home buyers, for the purchase of a primary residence only. (A first time home buyer is defined as a person who has not had any ownership interest in a primary residence in the last 3 years.)
  
  
• The tax credit is available only to first time home buyers who buy a primary residence between January 1, 2009 and December 1, 2009. (NOTE: The end date is December 1, NOT December 31!)
  
  
• The tax credit is available to U.S. Citizens, and possibly to resident aliens. This site says that the credit is available to "anyone who is not a nonresident alien (as defined by the IRS)", but that information was provided by the National Association of Home Builders, not by the IRS...
  
  
• This is a tax credit and not a tax deduction. It is a true dollar for dollar reduction on taxes owed.
  
  
• The credit can result in a true tax refund! If, for example, a qualifying first time home buyer were to get back zero on their 2009 taxes, they would then receive a tax refund for $8,000!
  
  
• The tax credit is not a loan and does not have to be paid back if the property is owned more than 3 years. If the home is sold within 3 years, the $8,000 tax credit must be re-paid.
  
  
• Single taxpayers with an Adjusted Gross Income (AGI) up to $75,000 and married taxpayers with a joint AGI of up to $150,000 are eligible for the full $8,000 credit. A lesser tax credit is still available for first time home buyers with income above these amounts, up to $95,000 for individual or $170,000 for joint AGI. For example, if your individual AGI was $85,000, you would get a tax credit of $4,000. If your AGI was $95,000, you would get zero.
  
  
• The credit can be claimed on the 2008 tax return even if the purchase was made on January 1, 2009 or later! A qualifying home buyer who has already filed their 2008 taxes can re-file and receive the tax credit after re-filing.
  
  
• The IRS form used to request the $8,000 tax credit is IRS Form 5405.
  

Here is some verbiage from the Act itself:

SEC. 1006. EXTENSION OF AND INCREASE IN FIRST-TIME HOMEBUYER
CREDIT; WAIVER OF REQUIREMENT TO REPAY.
(a) EXTENSION.—
(1) IN GENERAL.—Section 36(h) is amended by striking
‘‘July 1, 2009’’ and inserting ‘‘December 1, 2009’’.
(2) CONFORMING AMENDMENT.—Section 36(g) is amended
by striking ‘‘July 1, 2009’’ and inserting ‘‘December 1, 2009’’.
(b) INCREASE.—
(1) IN GENERAL.—Section 36(b) is amended by striking
‘‘$7,500’’ each place it appears and inserting ‘‘$8,000’’.
(2) CONFORMING AMENDMENT.—Section 36(b)(1)(B) is
amended by striking ‘‘$3,750’’ and inserting ‘‘$4,000’’.
(c) WAIVER OF RECAPTURE.—
(1) IN GENERAL.—Paragraph (4) of section 36(f) is amended
by adding at the end the following new subparagraph:
‘‘(D) WAIVER OF RECAPTURE FOR PURCHASES IN 2009.—
In the case of any credit allowed with respect to the purchase
of a principal residence after December 31, 2008,
and before December 1, 2009—
‘‘(i) paragraph (1) shall not apply, and
‘‘(ii) paragraph (2) shall apply only if the disposition
or cessation described in paragraph (2) with
respect to such residence occurs during the 36-month
period beginning on the date of the purchase of such
residence by the taxpayer.’’.
(2) CONFORMING AMENDMENT.—Subsection (g) of section
36 is amended by striking ‘‘subsection (c)’’ and inserting ‘‘subsections
(c) and (f)(4)(D)’’.
(d) COORDINATION WITH FIRST-TIME HOMEBUYER CREDIT FOR
DISTRICT OF COLUMBIA.—
(1) IN GENERAL.—Subsection (e) of section 1400C is
amended by adding at the end the following new paragraph:
‘‘(4) COORDINATION WITH NATIONAL FIRST-TIME HOMEBUYERS
CREDIT.—No credit shall be allowed under this section to any
taxpayer with respect to the purchase of a residence after
December 31, 2008, and before December 1, 2009, if a credit
H. R. 1—203
under section 36 is allowable to such taxpayer (or the taxpayer’s
spouse) with respect to such purchase.’’.
(2) CONFORMING AMENDMENT.—Section 36(d) is amended
by striking paragraph (1).
(e) REMOVAL OF PROHIBITION ON FINANCING BY MORTGAGE REVENUE
BONDS.—Section 36(d), as amended by subsection (c)(2), is
amended by striking paragraph (2) and by redesignating paragraphs
(3) and (4) as paragraphs (1) and (2), respectively.
(f) EFFECTIVE DATE.—The amendments made by this section
shall apply to residences purchased after December 31, 2008.

Section 179 Deductions

I just bought a book about tax deductions for landlords, which I really like. Most of the topics in there I already knew about, such as depreciation, mortgage interest, home office, real estate professional exemption, etc., and I am just clarifying the details on how it all works. But I came across one item that I've never even heard of -- Section 179 Expensing.

After going on about depreciation, the author then brings up Section 179, and states "Under Section 179, business owners can deduct the entire cost of long-term personal property that they use in their business, rather than having to depreciate the cost over several years. This is called first-year expensing or Section 179 expensing."

So I can buy a new car for my business, and deduct 100% of the cost of it in the year of purchase! I'm very surprised that I never heard of this before.

Here are the rules:

• Personal property used in rental property, such as appliances, carpets, and drapes, is excluded.
  
• You can't buy the deductible property from a relative or from an entity that you control.
  
• You have to use the property more than 50% of the time for business purposes. (If you use the property less than 100% of the time for business purposes, then you reduce the amount of your deduction by the percentage of personal use.)
  
• The maximum amount of expenses that you can deduct are currently $125,000 per year. But they're scheduled to go down to $25,000 in 2011.
  
• If you purchase more than $500,000 worth of Section 179 deductible items in a year, then you start to lose the deduction. That limit is scheduled to go down to $200,000 in 2011.
  
• You can't use these deductions to deduct more than you make, in profit plus salary. So you can't make your taxable income go below zero and create a loss.
  
• When you deduct the cost of an asset, you must continue to use it for business use for the length of time that you would have had to depreciate it. So, since a car would be depreciated over 5 years, you would have to keep using that car for business use for 5 years. Otherwise you will have to "recapture" the savings.
  

Pretty cool stuff!

Credit Score Breakdown

Credit Score Breakdown

I went to a credit repair company sales pitch today. One of the things I learned was the breakdown of how your FICO score is calculated.

The breakdown of your credit score (FICO score):

1. Payment History: 35%
   
2. Amount Owed: 30%
   
3. Length of History: 15%
   
4. Inquiries/New Debt: 10%
   
5. Types of Credit: 10%
   

Buying Your Credit Scores

You can get your credit report for free at annualcreditreport.com. But it doesn't include your FICO score. There are a lot of places on the Internet where you can buy your credit report with a score, but they generally aren't FICO scores, they are just estimates. Only FICO (Fair Issacs Company) provides the real scores that almost all lenders use.

But you can buy your actual FICO score at myfico.com, which is owned by Fair Issacs. It costs about $48. With a little searching I found some discount codes which got the price down to $38. The code I used was CPPSAVINGS (8/14/08). If that doesn't work, search around the net, or check out this forum which looks like it stays up to date.

You can also have a mortgage broker pull the credit for you, but that will cause a "hard hit" which decreases your scores. (A "soft hit" is when you pull your own credit, like with myfico, or when someone pulls your credit without you authorizing them, such as credit card companies who want to send you pre-approved offers.)