Is There A First-Time Home Buyer Tax Credit?

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 real estate taxes from your federal income taxes. You can deduct up to $10,000 combined. If you’re married and filing separately, you can deduct up to $5,000.

• 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.

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.

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 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.

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. The website usually provides a phone number to speak with someone directly, or they may have a contact form.

Was the first-time home buyer tax credit introduced by President Biden?

The bill was introduced in April 2021 but hasn’t passed yet. There are no indications the bill will pass before the next presidential election.

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 three years prior to purchasing the new principal residence.

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 have the ability to 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. 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.