Housing and Economic Recovery Act of 2008

(August 12, 2008)

First- time homebuyers and homeowners who do not itemize will reap benefits from the Housing and Economic Recovery Act of 2008.

On July 30, 2008 President Bush signed the Housing and Economic Recovery Act of 2008 (P.L. 110-289). The tax title, The Housing Assistance Tax Act of 2008, includes $15.1 billion in tax incentives that are fully offset by far-reaching revenue raisers. While the tax incentives are targeted principally to home ownership and affordable housing, the offsets are collected from a variety of sources. New provisions that require credit card purchase information reporting by merchants and the closing of a home sale exclusion loophole for vacation and rental property are among the more prominent offsets that will require a shift in tax strategies. The benefits (the up-side) and the offsets (the down-side) of the new bill are discussed below.

THE BENEFITS INCLUDE:

FIRST TIME HOMEBUYER CREDIT

The housing act gives first-time homebuyers nationwide a temporary refundable tax credit equal to 10 percent of the purchase price of a home, up to $7,500 ($3,750 for married individuals filing separately). The new credit phases out for single taxpayers with modified adjusted gross income (AGI) between $75,000 and $95,000 and modified AGI between $150,000 and $170,000 for married couples filing jointly. The credit is effective for homes purchased on or after April 9, 2008 and before July 1, 2009. Unlike other credits, however, the first-time homebuyer credit must be repaid to the government in equal installments over 15 years, essentially making it an interest-free loan from the government for most qualifying homeowners.

In addition, under the new law, two or more unmarried individuals may purchase a residence and qualify for the credit. They must allocate the amount of the credit between them as the IRS prescribes. However, the total amount of the credit allowed to the individuals jointly may not exceed $7,500.

The mechanics of the transactions is such that the IRS is not giving the $7,500 credit as cash at closing. The individual must claim the credit on a 2008 or 2009 tax return. However, a first-time buyer who purchases a principal residence in 2009 after filing a 2008 return has the option of filing an amended 2008 return to claim the credit. Purchasers also should investigate adjusting their wage withholdings or estimated tax payments for the balance of the year to account for the credit. As this strategy can produce varying results depending on the income earned during the year, it is suggested that purchasers contact their tax advisor to discuss the benefits or pitfalls of adjusting the tax withholdings or estimated payments.

Caution: The IRS will disallow the credit if the taxpayer disposes of the residence – or the residence ceases to be the taxpayer’s principal residence – before the close of the tax year for which the credit would be allowed (either 2008 or 2009). The IRS will also disallow the credit if the taxpayer is a nonresident alien, takes the expired, but likely to be renewed, District of Columbia first-time homebuyer tax credit or the taxpayer’s financing is from tax-exempt mortgage revenue bonds.

Repayment. Unlike any other individual federal tax credit, taxpayers must repay the first-time homebuyer credit. They will have 15 years to repay the credit, interest free. Repayments start two years after the year in which the residence is purchased. Payments must be made in equal installments over those 15 years.

PROPERTY TAX DEDUCTIONS FOR NON-ITEMIZERS

Currently, only individuals who itemize deductions may deduct real property taxes imposed by state and local governments. The new law gives non-itemizers a limited deduction for state and local real property taxes by increasing the amount of their standard deduction by the lesser of:
(1) The amount of real property taxes paid during the year, or
(2) $500 ($1,000 for a married couple filing jointly).

This temporary deduction is available only for 2008. Its cost over 10 years is $1.5 billion, all estimated to be incurred in 2009.

Impact. Taxpayers most likely to benefit from this deduction include homeowners who have paid off their mortgage (and, therefore, no longer itemize interest payments), taxpayers residing in states that have no state income tax (no state tax to include as an itemized deduction), and lower-income homeowners (whose overall itemized deductions generally do not exceed their standard deduction).
For 2008, the $10,900 standard deduction for joint filers and surviving spouses would increase to a maximum of $11,900, while the $5,450 standard deduction for single individuals increases to a maximum $5,950 and the head-of-household amount from $8,000 to $8,500.

The new deduction is in addition to the standard deduction. It is not an above-the-line deduction that lowers the amount of a taxpayer's AGI.

OTHER BENEFITS

Other benefits included in the Act are (1) a temporary increase in the low-income housing credit, (2) REIT changes, and (3) liberalized GO Zone incentives.

OFFSETS INCLUDED IN THE BILL:

REDUCED HOME SALE EXCLUSION

For individual taxpayers, gain from the sale of a principal residence home will no longer be excluded from gross income under Code Sec. 121 for periods that the home was not used as the principal residence (“non-qualifying use”). This new income inclusion rule applies to home sales after December 31, 2008, and, under a generous transition rule, is based only on nonqualified use periods that begin on or after January 1, 2009. In further relief from this new loophole closer, a period of absence generally counts as qualifying use if it occurs after the home was used as the principal residence.

Impact. The rule prevents use of Code Sec. 121’s exclusion of gain from the sale of a principal residence of up to $250,000 ($500,000 for joint filers) for appreciation attributable to periods after 2008 during which a residence was used as a vacation home or as rental property before its use as the principal residence.

Comment. Rather than require a valuation of the property on January 1, 2009, or at the time use is converted into a principal residence, however, the new law determines excluded appreciation on a pro-rata basis.
The amount of gain allocated to periods of nonqualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate period of nonqualified use during which the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. “Nonqualified use” for this computation does not include any use prior to 2009.

Example. Adam buys property on January 1, 2009, for $400,000 and rents it for two years, claiming $20,000 of depreciation. On January 1, 2011, Adam begins to use the property as his home. Adam moves out of the house on January 1, 2013, and sells it for $700,000 on January 1, 2014. The period 2009-2010 is non-qualifying use. The year 2013, after Adam moved out, is treated as qualifying use. Of the $300,000 gain, 40 percent (two years out of five years owned), or $120,000 is not eligible for the exclusion. The balance of the gain, $180,000, may be excluded. The $20,000 gain attributable to depreciation is recaptured, as required under current law.

CREDIT CARD INFORMATION REPORTING

For banks and other processors of debit and credit cards as well as business taxpayers who accept debit and credit cards from their customers will be impacted by this offset.

Under the new law, banks and other processors of merchant payment card transactions (credit and debit cards) will be required to report a merchant’s annual gross payment card receipts to the IRS (and to the merchant). The new law also requires reporting on third-party network transactions (such as ones used by many online retailers). Merchants and payment card processors have time to prepare. The new treatment is effective for sales made on or after January 1, 2011.

The “paper trail” created by payment cards is currently unavailable to the IRS except on a case-by-case basis. The new law changes this. According to the Treasury Department, expanded information reporting will assist the IRS in increasing the compliance rate among merchants. It plans to compare the merchant’s overall volume of payment card sales in relation to expenses claimed and cash transactions reported. The new reporting is estimated to raise more than $9.5 billion.

Many small businesses were opposed to expanded payment card information reporting, warning that the high costs of credit and debit transactions are already driving many merchants away from these transactions.

De minimis exception. The new law creates an exception from information reporting if the aggregate value of third party network transactions does not exceed $20,000 for the calendar year or the aggregate number of these transactions does not exceed 200.
Among the issues that the IRS will have to address in regulations are charge-backs (where a merchant is debited for the amount that a credit card company refunded to a customer when the customer returns a purchase) and transactions in which the customer receives “cash back” as well as merchandise.

Comment. The new law requires the reporting party to provide the IRS with the merchant’s TIN. If the reporting party cannot provide this information, it would be required to withhold at 28 percent the payments to the merchant. Typically, backup withholding is imposed on income, such as interest or dividends, with no offsetting deductions. Here, it would apply before the merchant deducts any offsetting expenses.