Repay entire tax credit after foreclosure?

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Dear Real Estate Adviser,
I bought a home in mid-2008 using the $7,500 first-time homebuyer tax credit. I lost the home to foreclosure in late 2011 due to job loss. I repaid the first installment of $500 for this credit in my 2010 taxes. Since I lost the home and made no money from it, will I have to pay back the remaining $7,000? The regulations say if you don’t sell to a family member and make no profit from the house, you don’t have to pay it. Is a foreclosure any different?
— Pamela W.

Dear Pamela,
Yes, a foreclosure is different in this case, and you most likely — though not definitely — won’t have to pay back that sum.

First, let’s back up a minute. You bought your home under the first-time buyer provision of the Housing and Economic Recovery Act of 2008, which was essentially an interest-free loan program. Had you made the purchase under the revised 2009 program, you probably wouldn’t have had to even worry about paying back the first-timer money. That’s because it became a “credit” and was upped to $8,000 in 2009, assuming you didn’t sell before a three-year period expired. It’s called patchwork legislation.

Here’s how those 2008 deals were structured. If your house stopped being your main home at any point during the 15-year period in which you were to repay the loan, you were obliged to repay the balance of the credit on your next tax return, a phenomenon the Internal Revenue Service calls “acceleration of recapture.”

But — and this is a very big “but” — the law imposes a cap, in some cases, on how much you must repay. You don’t have to repay more than the gain you make on the home’s sale, under most scenarios. This is important when the property is taken back in foreclosure, because only a minuscule number of foreclosure sales result in profits.

If the foreclosure sale somehow did result in a gain, you would compare your original purchase price to the price that the foreclosure sale netted. If that foreclosure sale somehow brought in more dough than your purchase price, you’d have to pay back the difference or $7,500, whichever number was smaller. For a nonrecourse loan (your old lender can tell you if your loan was nonrecourse), the calculations would change somewhat.

Again, this is moot because nearly no homeowners turn profits on foreclosure sales these days, with the exception of a few in very popular land-constrained urban areas such as New York or Southern California. Hence, you likely have no tax consequences due to your foreclosure. However, your individual financial circumstances (and ideally, a tax professional) will ultimately determine that.

I’m sorry to hear of your job and home loss. In case you’re curious, you needn’t count out homeownership ever again. Fannie Mae, Freddie Mac and the Federal Housing Administration say there’s typically only about a three-year wait before you can successfully apply for a mortgage loan again after a foreclosure that was caused by extenuating circumstances, assuming you land gainful employment again.

Good luck getting back on your feet.

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