taxes

Must pay back first-time homebuyer credit?

Judy O'ConnorDear Tax Talk,
We bought a home in 2008 and received the $7,500 tax credit. We lost our jobs shortly after and tried to keep the home. We finally had to list our house for sale in June 2013. We stopped making payments and moved to a smaller home in a different town for work.

In January 2014, the house had an offer below what we owed, and we tried to short sale it. But the USDA (where our home loan came from) and our current mortgage company had a hard time and it took 18 months to be approved for a short sale. We lost the house offer.

We are finally approved for a short sale, and it's tax-filing time. It says on our taxes that we have to pay the rest of the loan back -- $2,500 since we did not live in the home in 2014. My Realtor said that some homes that are in distress sales might not have to pay it all back. Our home is currently listed for $30,000 less than what we purchased it for.

Our home now has a scheduled foreclosure date, but we hope to short sale it before then.

Since we have not sold the house, would this still be a distress sale? Must we pay all of that back at once?

Please help. It would be very much appreciated.
-- Tiffany

Dear Tiffany,
Taxpayers who qualified for the first-time homebuyer credit for home purchases made between April 9 and Dec. 31, 2008, have been required to repay the credit at the rate of $500 per year for 15 years starting in 2010. If you do not remain in the home for the required 15 years, the repayment of the credit is accelerated. However, there are certain exceptions to this rule, and I believe one of them may apply to you.

IRS Form 5405, Repayment of the First-Time Homebuyer Credit, is where you will see all the situations where you might find some relief. In your case, if you take a look at Part 1, Line 3b, you will see that if you sell your home (including through foreclosure) to a person who is not related to you and you do not have a gain on the sale, then no repayment of the credit is required. I believe this is where your Realtor was heading when "distress sale" was mentioned.

This is a completely different set of rules from the taxpayers who purchased after 2008 and are not subject to any repayment of the credit if they have owned and lived in the home for at least 36 months starting with the purchase date. What a lucky group they are!

Exceptions to the rule

There is another complicated issue you will be facing regarding the Mortgage Debt Relief Act of 2007. This was effective for debt forgiven from 2007 to 2014, when taxpayers could exclude income from the discharge of debt used to buy, build or substantially improve their main residence. To date, this provision has not been extended through 2015. But that does not mean all hope is lost, as Congress could revisit this highly publicized issue.

Thanks for the great question and all the best to you as you move forward.

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