How the First-time Homebuyer Tax Credit Worked

With the housing bubble bursting and the 2008 recession rearing its ugly head, many would-be homeowners balked at making such a huge financial commitment as buying a residence. However, the First-Time Homebuyer Credit assuaged some of the fear, by assuming a lower financial risk. "The newer homes in the area we wanted to live were out of our price range," explains Christy Cook, who cashed in on the credit in 2009. "We opted to buy an older home, so the tax credit helped us to fix some things that needed attention, which we wouldn't have been able to do otherwise."

The credit was available to first-time homebuyers during the time frame of April 8, 2008 to May 1, 2010, for the purchase of a full-time dwelling only. In other words, no fair buying it and then turning it into a profitable rental or vacation home! Interestingly, if a person purchased the residence and lived there full time, she could then rent out other portions of the home and still be able to receive the credit [source: IRS].

The term "first-time buyer" was relatively flexible, as the credit was up for grabs to those who had never owned a home, or who had not owned a residence in at least three years [source: Manni]. The amount available ranged from 10 percent of the home's purchase price, up to a max of $7,500 or $8,000, depending on year of purchase. So, homebuyers in at least the $75,000/$80,000 price range were able to take full advantage of the perk.

In a twist that pleased many, the U.S. government expanded the credit to long-time homeowners just itching to upgrade to a replacement home. Purchase had to take place after Nov. 6, 2009, for a maximum $6,500 credit [source: IRS]. Long-time homeowners were defined as having owned and used the property as a principal residence for a minimum of five years. That half-decade period had to take place consecutively within the eight years before applying for the credit [source: Bell]. For families or other owners interested in shedding a starter home for something roomier, this credit was just the kick in the pants they needed to start house-hunting, if with a little bit of extra caution.

Everyone's always looking for the "catch" in a situation that seems too good to be true ... because so many of them are! Surprisingly, the requirements for the tax credit were fairly upfront and easy to understand, especially once the 2008 interest-free loan "credit" and all its repayment requirements was swapped for the actual credit of 2009.

Provided a person qualified as a first-time homebuyer or a long-time homeowner, there were a few basic regulations that had to be followed. Pretty much any type of principal residence could be purchased, as long as it could be affixed to land. So, single-family houses, townhomes, apartments, duplexes, mobile homes and even travel trailers (so long as they were affixed) qualified. RVs, however, were considered personal property not attached to any particular tract of land, so they were not eligible to redeem the credit. By the same token, a potential buyer who had lived in an RV was considered a first-timer, and therefore able to receive the credit if permanent home ownership became enticing.

Personal income was also a deciding factor, with the credit either lowered or eliminated altogether for buyers who made too much money. Known as the phase-out range, the income limits were [source: IRS]:

A few other stipulations were in place, in addition to the income caps and principal residence rules. For example, nonresident aliens could not receive the credit, and neither could buyers purchasing a home from a close relative, like a parent, spouse, grandparent or child.

Sometimes, moves happen, whether or not we want them to. Unfortunately, these situations impacted people who'd previously enjoyed the credit. For example, if a homeowner decided to sell the home or stop using it as a principal residence less than 36 months after closing on the property, the credit had be repaid in full via the income tax return of the affected year. This applied only to the 2009 true credit [source: IRS].

However, anyone who received the 2008 interest-free loan "credit" would have to pay all remaining installments in the event of a move. On the upside, if the seller broke even or lost money on the home sale, the repayment could actually be lowered or axed completely [source: IRS].

And now for the million-dollar question: Was the first-time homebuyer tax credit a success, or an epic disaster? As with many things government-related, that all depends on who you ask. The U.S. government spent $16.2 billion in an effort to boost the housing market, with 2.3 million people participating in the credit program. According to the Center for Economic and Policy Research (CEPR), the credit did help to initially boost home sales and prices, although relatively modestly, until the program expired in April, 2010. This occurred because people who would have otherwise waited a year or two to purchase decided to flood the marketplace to take advantage of the credit. However that left a dearth of buyers for the rest of 2010 and 2011. Housing prices fell another 8.4 percent from second quarter 2010 (the end of the program) to the end of 2011. They continued falling well into 2012 [source: Baker].

Some experts say that the credit allowed some home sellers to get prices for their homes that were still inflated by the housing bubble -- which also meant that some home buyers paid more for their homes than they otherwise would have. The clear winners for the credit were the mortgage lenders who didn't have to accept as many short sales, and home builders who could sell houses at higher rates because of the delay in the bubble's deflation [source: Baker].

There are almost certainly scores of people for whom this deal went south, including those who had to relocate and thus were required to pay back the government, or others who lost their jobs and couldn't make even modest mortgage payments. On the flip side, the credit inspired many to put down roots earlier than they expected, and if the housing market continues on a gradual, but upward trend, they could stand to profit down the line. "As a single woman, I probably would have waited until I found a partner to live with before buying, if it were not for the tax credit," says Ryan O'Neill, who purchased her Atlanta-area home in 2010. "It allowed me to buy a house all by myself, which was very empowering."