Real Estate Matters

When it comes to home buyer tax credits, IRS rules can be strict

By Ilyce R. Glink and Samuel J. Tamkin
Saturday, April 24, 2010

Q: I purchased a home about a year ago, but I used a land contract. The contract started three years ago. By the time the loan was closed on the land contract, the contract was no longer valid. I paid real estate taxes and mortgage interest because it was included with our rental payments.

I have received a letter from the IRS saying we do not qualify for the first-time home buyer tax credit. I have looked through all of the instructions and eligibility requirements and have found no mention of land contracts. This is our first time buying a home, and I feel like I am being punished.

A: It's interesting that you purchased your home using a land contract. In some parts of the country, these contracts are referred to as "purchases installment contracts for deed" or "contracts for deed."

In essence, when you buy a home in this manner, you close on the initial purchase of the home with a down payment and an obligation to make future payments until you have satisfied the contract. When you satisfy the obligations under the land contract, the seller of the property transfers the title to you.

Unfortunately for you, for legal purposes and for IRS purposes, you are considered the owner of the home upon the initial purchase of the home. Although you don't have the title to the home, you are considered the owner and can deduct the interest payments on the land contract as well as real estate taxes paid on the home.

You are treated as the owner of the home, and the seller is treated as the lender. What's different about other owner-lender arrangements is that in those arrangements the borrower actually has title to the home.

There is a principle in law that permits you to move into the home and start making payments on the land contract and to be treated as the owner of the home. The seller holds the title to the home pending your payments on the land contract, but the seller no longer controls the home. You control the home.

The IRS must have seen that in your past returns, you deducted interest on the home and might have deducted the real estate taxes. As such, you cannot be treated as a first-time buyer in 2009. According to their records, you bought your home in 2007.

The first-time home buyer tax credit rules are quite strict about the ownership requirements and dates. Unfortunately, since the IRS considers you to have bought your home in 2007, you do not qualify.

Q: I have $50,000 sitting in a money market account. I owe approximately that amount on my mortgage. I have a 401(k) of about $325,000 and another retirement account worth approximately $400,000. Should I pay off my mortgage?

A: Even with the economy on an upswing, I'd hate to see you use up every last cent of your liquid cash paying off your mortgage, particularly if you have a low interest rate or are at the point in your loan that your monthly payments go mostly toward reducing the principal balance on the loan.

But if you can immediately start socking away into a savings account the cash you won't be using to pay down your loan each month, and if you have other cash available in case of emergency, that would work.

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