Is there a first-time home buyer tax credit?

As a first-time home buyer, you might be wondering what, if any, financial incentives exist to help you make the most of this significant purchase.

While there isn’t a first-time home buyer tax credit currently in place, several programs exist at the federal, state and local levels that you can take advantage of when you purchase your first home.

In this article, we’ll cover what a first-time home buyer tax credit is as well as the history and current status of this type of credit. We’ll also look at a variety of tax deductions and programs that are currently available to assist first-time home buyers.

What is a first-time home buyer tax credit?

Before you can understand what a first-time home buyer tax credit is, it’s important to understand what tax credits are and why they exist. According to the Internal Revenue Service (IRS), a tax credit is a dollar-for-dollar amount taxpayers claim on their tax return to reduce the income tax they owe. The government uses tax credits to incentivize taxpayers to do certain things, such as buy a home.

About 14 years ago, a tax credit of up to $8,000 was available to those who were purchasing their first home. While several similar bills have been proposed by lawmakers in recent years, nothing has been passed into law yet.

Below we’ll talk more about what the first-time home buyer tax credit looked like in the past and what propositions are currently stalling in Congress.

Who qualifies as a first-time home buyer?

While the phrase “first-time home buyer” might seem self-explanatory as to who it's referring to, there are actually quite a few scenarios in which someone can qualify. Specifically, one of the following needs to be true to be considered a first-time home buyer:

• You haven’t owned a primary residence in the last 3 years.
• You’re a single parent who has only owned a property with a former spouse while married.
• You’re a displaced homemaker who has only owned property with a spouse.
• You’ve only owned a primary residence not permanently affixed to a permanent foundation.
• You’ve only owned property that wasn’t in compliance with the state, local or model building codes and can’t be brought into compliance for less money than it would cost to build a permanent structure.

If you fall within th ese criteria and you’re looking for assistance with your first home purchase, there are a number of tax deductions and programs that you can take advantage of. We’ll get into these a little later on.

Tax deductions for first-time home buyers

It’s important not to confuse tax credits with tax deductions. While a credit is a one-for-one reduction of your tax bill, a deduction lowers your taxable income.

For example, a $500 deduction means that if your original taxable income is $60,000, your taxable income after the deduction would be $59,500. While your taxes may be reduced, they won’t necessarily be $500 less.

There are many tax deductions for homeowners. While we’ll cover deductions you can take at the federal level, there may be deductions you can take at the local and state level.

• Mortgage interest deduction: If you’re buying a home today, you can deduct the interest on mortgage balances up to $750,000 ($375,000 if married and filing separately). If your home was purchased prior to April 1, 2018, the limit is $1 million for joint filers and $500,000 if you’re a married couple filing separately.
• Property tax deduction: You can deduct local property taxes from your federal income taxes. If you’re single, or married and filing separately, you can deduct up to $5,000. You can deduct up to $10,000 as a couple filing jointly.
• Loan origination fee deduction: You can deduct points paid for the cost of originating your mortgage. In most cases, you have to deduct this cost over the life of the loan instead of all at once in the year of your purchase. Consult a tax advisor on your situation.
• Mortgage points deduction: You might choose to purchase optional discount points from your lender when you take out a mortgage. You’ll pay an up-front fee in exchange for a lower interest rate on your loan. If a homeowner meets certain criteria put forth by the IRS, they can typically deduct the cost of the discount points as interest when filing taxes.

Residential energy credits

While not a deduction, there are also residential energy credits you can take for the purpose of making your home more energy efficient. There are a couple of different programs here. The first allows you to take a credit of 30% of the cost of qualified improvements like solar or wind electricity generation, biomass fuel or a geothermal heat pump.

The second credit is geared toward smaller-scale energy improvements like replacing windows and doors or adding new insulation. Consult a tax advisor for more details.

It’s important not to confuse tax credits with tax deductions. While a credit is a one-for-one reduction of your tax bill, a deduction lowers your taxable income.

For example, a $500 deduction means that if your original taxable income is $60,000, your taxable income after the deduction would be $59,500. While your taxes may be reduced, they won’t necessarily be $500 less.

There are many tax deductions for homeowners. While we’ll cover deductions you can take at the federal level, there may be deductions you can take at the local and state level.

• Mortgage interest deduction: If you’re buying a home today, you can deduct the interest on mortgage balances up to $750,000 ($375,000 if married and filing separately). If your home was purchased prior to April 1, 2018, the limit is $1 million for joint filers and $500,000 if you’re a married couple filing separately.
• Property tax deduction: You can deduct local property taxes from your federal income taxes. If you’re single, or married and filing separately, you can deduct up to $5,000. You can deduct up to $10,000 as a couple filing jointly.
• Loan origination fee deduction: You can deduct points paid for the cost of originating your mortgage. In most cases, you have to deduct this cost over the life of the loan instead of all at once in the year of your purchase. Consult a tax advisor on your situation.
• Mortgage points deduction: You might choose to purchase optional discount points from your lender when you take out a mortgage. You’ll pay an up-front fee in exchange for a lower interest rate on your loan. If a homeowner meets certain criteria put forth by the IRS, they can typically deduct the cost of the discount points as interest when filing taxes.

Residential energy credits

While not a deduction, there are also residential energy credits you can take for the purpose of making your home more energy efficient. There are a couple of different programs here. The first allows you to take a credit of 30% of the cost of qualified improvements like solar or wind electricity generation, biomass fuel or a geothermal heat pump.

The second credit is geared toward smaller-scale energy improvements like replacing windows and doors or adding new insulation. Consult a tax advisor for more details.

Programs and assistance for first-time home buyers

While there is no federal residential purchase credit, there are other options for first-time home buyers looking for assistance.

HUD assistance

The Department of Housing and Urban Development (HUD) offers a variety of homeownership assistance to those looking to purchase a home. One of the biggest things they can help first-time home buyers with is housing counseling. This involves taking a hard look at your financial situation to know how much you can afford and whether you’re ready to move forward.

Mortgage Credit Certificates (MCCs)

State housing finance agencies can work with the federal government to convert some of their funding into mortgage credit certificates. These allow low- to moderate-income Americans to claim a credit for a portion of the mortgage interest they pay each year. The calculation is a little complicated, so speak with a tax expert if you have any questions.

State-sponsored assistance

States sometimes offer assistance programs to help their residents achieve homeownership. It’s a good idea to research what may be available in your area. A good place to start is the directory of local home buying programs maintained by HUD.

Borrow from an IRA or Roth IRA

If you have a traditional or Roth individual retirement account (IRA), you would typically pay a 10% penalty in additional taxes on any IRA withdrawal you make before age 59 ½. However, there’s an exemption that may benefit first-time home buyers.

Qualifying first-time home buyers can take out up to $10,000 of distributions penalty-free to buy, build or reconstruct a first home.

For the purposes of this section of the tax code, a first-time home buyer is defined as anyone who hasn’t owned a primary residence in the 2-year period leading up to the acquisition of the home. Also, you must use the funds to purchase or build the home within 120 days of withdrawal.

Although there’s no additional tax penalty, the distributions you take are subject to regular income tax regulations. Speak with a tax advisor about your situation.

Loan from employer-sponsored plans

In addition to the IRA carveout, it’s legal for your employer to offer loans out of retirement accounts they sponsor. The IRS says you can borrow up to 50% of your vested account balance or $50,000, whichever is less.

Normally, the loan from your retirement plan must be paid back within 5 years with a minimum of quarterly payments. However, you may be able to pay off the loan over a longer period if you use the money to buy a primary residence.

You’ll want to be careful with this. If you leave the company, the terms of your loan may call for immediate repayment. Additionally, if you don’t make payments, it may be treated as an early distribution. If you take the money before age 59 ½, it may be subject to a 10% tax penalty in addition to regular income taxes.

We can’t say this enough: Talk to a tax advisor.

Down payment assistance

Most types of mortgage loans require a down payment, which is a percentage of the home’s purchase price that you pay upfront. Fortunately for those who are purchasing their first home, a variety of down payment assistance options exist for first-time buyers, including loans and grants.

• Down payment assistance loans: Certain types of loans including second mortgages, deferred payment loans and forgiven loans can reduce the amount you have to put down on a house.
• Down payment assistance grants: Grants that are designed to assist first-time buyers with their down payment don’t have to be repaid.

It’s a good idea to check with your local or state government for details on any down payment assistance programs since eligibility requirements can vary.

Government-backed home loans

First-time home buyers who are hoping to make a low down payment or find a loan they can qualify for with lower credit might take interest in a government-backed home loan. There are three options, including FHA loans, VA loans and USDA loans.

• FHA loans: Backed by the Federal Housing Administration (FHA), FHA loans allow eligible borrowers with a credit score of 580 to take out a mortgage with a 3.5% down payment.
• VA loans: Courtesy of the Department of Veterans Affairs, VA loans provide affordable housing opportunities to qualified service members, veterans and surviving spouses. These loans have flexible credit score requirements and don’t require a down payment.
• USDA loans: Designed for eligible home buyers in certain rural areas of the U.S., some U.S. Department of Agriculture (USDA) loans don’t require a down payment on a home purchase.

First-time home buyer tax credit FAQs

Below are some common questions about tax breaks for new home buyers.

How do I know if my state offers first-time home buyer tax credits?

We recommend reaching out to your state’s department of revenue to find out if there are any first-time homeowner tax credits available to you. The website usually provides a phone number to speak with someone directly, or they may have a contact form.

What’s the difference between a tax credit and a tax deduction?

A tax credit and tax deduction can both lower your tax bill, but they do so in different ways. A tax credit is a dollar-for-dollar reduction on the tax that you owe. A tax deduction, on the other hand, reduces your taxable income.

How does a tax credit work for first-time homeowners?

A tax credit reduces the amount of income tax first-time homeowners owe when they file their taxes. While there isn’t currently a tax credit for first-time buyers in place, there are a variety of tax deductions and other assistance programs first-time buyers can benefit from.

What is the IRS definition of a first-time home buyer?

Definitions can change depending on the part of the tax code you’re reviewing. For the purposes of the proposed First-Time Homebuyer Tax Credit bill, a first-time home buyer cannot have owned a home for 3 years prior to purchasing the new principal residence.

The bottom line: There Isn’t Currently a first-time home buyer tax credit

Despite recent attempts, there is currently no first-time home buyer tax credit available at the federal level. However, that doesn’t mean there aren’t options available in your state. States also can issue mortgage credit certificates that can be used to lower income taxes dollar-for-dollar. Be sure to ask your mortgage lender for suggestions as well.

Additionally, deductions can lower your tax liability, even if they don’t do so on a one-to-one basis. Finally, you can look at everything from state-sponsored assistance to taking out a retirement plan loan. Especially if you choose to go the latter route, consult a tax expert.

If you’re ready to think about financing, start your mortgage application online.

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