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New Law Adds Tax Breaks for Real Estate

Posted on Aug 4, 2008 by Mike Geyer

Recently, lawmakers slipped plenty of new tax breaks for real estate into newly enacted legislation that is intended to provide relief from the current mortgage crisis. Taxwriters have approved tax cuts worth $12.4 billion over 10 years, as well as tax increases to offset them.

Filers who do not itemize deductions can deduct real estate taxes they paid in 2008 in addition to their standard deduction. The extra write-off is capped at $1,000 for married people and $500 for singles. But this break only lasts a short time. It is scheduled to expire after this year. People who itemize their deductions aren’t affected, unless the sum of their standard deduction and the special real estate tax deduction exceed their total itemized deductions. In that case, they will be better off with the enhanced standard deduction. First-time home buyers get a tax credit of up to $7,500 for buying a main home after April 8, 2008, and before July 1, 2009. To be eligible, purchasers must not have owned a principal residence in the U.S. in the previous three years. The credit phases out between $150,000 and $170,000 of adjusted gross income for married couples and $75,000 to $95,000 for single filers. The tax credit is refundable to the extent it exceeds the buyer’s regular tax liability, but does not offset the alternative minimum tax. Home buyers in 2009 can make a special election to take the credit on their 2008 income tax returns. That may require the filing of an amended return for 2008.

Also, first-time home buyers get a tax credit of up to $7,500 for buying a main home after April 8, 2008, and before July 1, 2009. To be eligible, buyers must not have owned a principal residence in the U.S. in the previous three years. The credit phases out between $150,000 and $170,000 of adjusted gross income for married couples and $75,000 to $95,000 for single filers. The tax credit is refundable to the extent it exceeds the buyer’s regular tax liability, but does not offset the alternative minimum tax. Home buyers in 2009 can make a special election to take the credit on their 2008 income tax returns. That may require the filing of an amended return for 2008.

But the credit is really only an interest-free loan from the government. The new law requires it to be recaptured evenly over a 15-year period, without any interest due, starting two years after the year the credit is claimed. Thus a first-time home buyer who claims a $7,500 tax credit for a purchase in 2008 must pay an extra $500 of income tax in 2010 and in later years. If the homeowner sells the residence before the credit is fully repaid, the seller is taxed that year on the lesser of the gain from the sale (if sold to an unrelated party) or the unrecaptured balance of the credit.

Now turn to the two major revenue-raising provisions. Congress restricted a tax break for turning a second home into a main home: Some of the gain will be ineligible for the home-sale exclusion if the house is converted to personal use after 2008 and is later sold. The portion of the profit that’s taxed is based on the ratio of the time after 2008 when the home was used as a second residence or rented out to the total time that the seller owned the house. The rest of the gain remains eligible for the home-sale exclusion of up to $500,000 if you owned and used the house as your primary residence for two out of the five years prior to selling it.

This tightening may not bite you too badly if you owned the house for many years before converting it.