Sunday, February 8, 2009

Here comes the scam (sung to the tune of “Here Comes The Bride”)

All of the wrangling is over and after the pendulum swung widely on the issue of a credit for home buyers, we ended up with virtually the same first-time home buyer credit we already had with the following modifications: 1) the credit is increased to $8,000; 2) the payback provision is eliminated for houses purchased in 2009; and 3) the purchasing window is extended to November 30, 2009.

Here is the summary of the conference committee first-time home buyer credit:

Refundable First-time Home Buyer Credit.
Last year, Congress provided taxpayers with a refundable tax credit that was equivalent to an interest-free loan equal to 10 percent of the purchase of a home (up to $7,500) by first-time home buyers. The provision applies to homes purchased on or after April 9, 2008 and before July 1, 2009. Taxpayers receiving this tax credit are currently required to repay any amount received under this provision back to the government over 15 years in equal installments, or, if earlier, when the home is sold. The credit phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). The bill eliminates the repayment obligation for taxpayers that purchase homes after January 1, 2009, increases the maximum value of the credit to $8,000, and removes the prohibition on financing by mortgage revenue bonds, and extends the availability of the credit for homes purchased before December 1, 2009. The provision would retain the credit recapture if the house is sold within three years of purchase. This proposal is estimated to cost $6.638 billion over 10 years.

* * * * *
(Original Post)
This week’s post is not a humor column. This is my prediction of the unintended consequences of an amendment to the Economic Stimulus Bill to be voted by the Senate on Tuesday. The House and Senate bills will be reconciled immediately after the Senate vote with the objective of getting the compromise bill approved and moved to Obama’s desk before the President’s Day hiatus.

The amendment was proposed by Georgia Senator Johnny Isakson, a former realtor, to stimulate the housing market. In a nutshell, it provides for a nonrefundable tax credit (the word nonrefundable means that the credit offsets one's tax liability, but to the extent that the credit is larger than the tax liability, it goes unused) of up to ten percent of the purchase price of a principal residence, capped at $15,000. It would apply to real estate closings occurring for one year from the date that Obama signs the bill into law.

The credit would be paid over two tax years at $7,500 per year, generally the year of the purchase and the year after, though it’s looking like purchases made in 2009 may qualify for a credit on your 2008 tax return. Presumably this would apply to closings that occur prior to the personal tax return extension deadline of October 15th or possibly any closing occurring in 2009 and reported on the 2008 Form 1040 via an amended return.

This proposal is different from the current $7,500 first-time homebuyers (defined as people who have not owned a principal residence for more than three years) “credit” (which requires repayment of the $7,500 “credit” over 15 years) as well as the modified House version (which makes the credit refundable and eliminates the payback provision). The amount is increased, obviously, but the major change is that Isakson’s proposal applies to anyone’s purchase of a principal residence, not just first-time homebuyers.

That’s where the unintended consequences come in. Let’s say that there are next door neighbors who both bought their houses during the loose credit heyday, qualifying for their interest-only mortgages without even having to substantiate their incomes (often called “no-doc” or “Alt-A” loans). The interest rates have moved up substantially from the teaser rates that expired a year or two after the loan documents were signed.

Normally, people in this situation would be looking to refinance their mortgages into conventional fixed-rate loans, a no-brainer given the low interest rates available in today’s marketplace. So, let’s assume that our next door neighbors both have the means to qualify for a refinancing, but there’s a much better option out there thanks to Senator Isakson.

Since the first-time homebuyer requirement has been dropped, our next door neighbors are eligible for the $15,000 credit. Rather than refinancing their current loans, why not buy each other’s houses? They’ll still incur closing costs, but they eliminate the realtor’s commission, which is usually six percent of the sales price. They’d have to pay closing costs on a refinancing transaction anyway. Nothing lost there.

What’s to be gained, however, is that each family can then get a $15,000 credit on their tax returns. That would cover all of the closing costs and most likely leave $12,000 or so for pocket change. Multiply that by two and we have $24,000 transferred from the rest of us to our next door neighbors.

Has this transaction bolstered the housing industry? Hardly. Do realtors benefit? I don't see how. The $24,000 might have a stimulative effect, assuming they spend the money on something besides debt reduction, but the primary purpose of Isakson’s proposal would have been circumvented. The neighbors wouldn’t even have to move into each other’s houses as long as they change their addresses for legal purposes or just use post office boxes to hide what’s happened.

I’m certainly not advocating that anybody should pull a stunt like this, but I am painting a scenario that needs to be dealt with in the enacting legislation or by the IRS. The shift from first-time homebuyers to any homebuyers opens this loophole.

There is no doubt that the stimulus package will involve huge amounts of wasteful spending, unimpeded by any diligent oversight; just as we saw with Katrina aid and the financial sector bailout. So, if I can help plug at least one hole in our ship that is quickly sinking into the ocean of socialism, I feel better.

(My concerns have been communicated to Senator Isakson’s office in an email I sent last week.)

Copyright 2009 Randy Hunt


  1. Randy, What happens if the 2 neighbors decide to sell their houses to each other, lets say twice during a year,or year and a half period. Is there a provision to prevent this and collecting another $15,000 each? Frank

  2. Frank, there is a requirement to own the house for two years, otherwise you have to pay back the credit. Because the credit will only apply to houses purchased within one year of the bill's enactment, you wouldn't be able to go after the credit more than once.

  3. What if you are buying a house on 02/11/09. Does this mean you will be left out in the cold even though you are "Stimulating the economy in 2009"? Does this only apply to purchases made AFTER the bill is signed into law?

  4. If you qualify as a first-time homebuyer, then the current $7,500 credit would be available to you. The House bill removed the payback requirement for mortgages originating starting 1/1/2009. (Of course, that bill hasn't been signed into law either.) If you don't qualify as a first-time homebuyer you're, as you say, left out in the cold if you bought the house prior to the bill being signed into law.

  5. Randy: Thanks for the comments. Very insightful and interesting. I understand from your comments that the senate tax credit would only apply to the purchase of principal residence. Is that correct? How is principlal residence determined? Thanks

  6. "Principal residence" is not directly defined in the Internal Revenue Code. It has been "defined" by a series of tax court rulings, IRS interpretations, regulations, etc. Nothing's simple when it comes to taxes, but the following definition is the one I use when trying to make a determination of the facts and circumstances:

    "Ordinarily, the taxpayer's “main home” (or principal residence) is the home in which the taxpayer lives most of the time. Under the cases, rulings and regs interpreting and explaining prior-law's home sale rollover rules ( ¶ 225,800 et seq.), a principal residence could include a conventional single family structure, house trailer, mobile home, houseboat, condominium ( ¶ 226,313 ), cooperative apartment ( ¶ 226,312 ), duplex or row house, and could also include a yacht which contains facilities for cooking, sleeping and sanitation. It didn't include any item of personal property, such as furniture, a radio, etc., that was not a fixture under local law."

  7. And yes, Anonymous, both the Senate and House versions of the credit apply only to the purchase of a principal residence.

  8. Randy, Do you think that the cumulative effect of outsourcing of jobs has reduced the income stream to the very homeowners that are losing their homes? Big companies certainly do benefit from reduction in salary expense. The aggregate of many this trend seems to lead to a crash of salaries, and Real Estate. How many of these recent "layoffs" are actually sending jobs overseas?

    J Westerdale

  9. Randy, Do you think that the widespread outsourcing of US jobs has contributed substantially to the rampant increase in foreclosures?

    There may be a percentage attributable to unsupportable mortgages, but the widespread loss of jobs has to add to the list of lost homes.

    Calling it "Toxic Debt" makes it seem like its from some unknown cause. I think its a case of global salary commoditization.

    Companies certainly benefit from reduction in salary expense, but the society suffers. How many of these recent "layoffs" are actually sending jobs overseas?

    Are they really layoffs, or massive outsourcing?

    IBM leader Sam Palmisano's cold rationalization of outsourcing jobs based solely on cost looks good on paper, but is not a sustainable model. Does he expect that Americans can live here (US) and accept a wage thats competitive with another from a developing country? Why do we lavish him with praise while he is selling us out?

    It doesn't take a smart person to see that our culture will crash with him at the helm, feeling all mighty and glorious.

    I think it stinks, and wonder what he advises his children to take up as they become members of the job market? An executive position at the local gas station?

    I don't have a solution to globalized salary leveling, just know that its going to wreck what put him in place.

    J Westerdale

  10. John, you make some excellent points. I've long held the view that regionalization of services results in a watering down of quality and the migration towards mediocrity.

    On a local level, we often debate the merits of regionalizing municipal services; two or three towns working together to provide firefighting/EMS services, or even something as simple as animal control services.

    It makes for a great solution, in theory, but in reality the quality and cost of the regional services invariably drift towards an average of the prior services. That's good for towns that have costly or low quality services; they tend to enjoy cheaper, higher quality services after regionalization. But the towns that had high quality, efficient services before regionalization get a watered down result. Lower quality, higher cost.

    Now take that pattern to a global level. Job outsourcing seeks a lowering of costs, but it generally results in a lessening of quality. So the entire world makes this migration towards a median of lower costs (read that as lower standard of living) and lower quality (just look at the Chinese-made toys fiasco as one example of that).

    This shift is good for third world countries, which reap the benefits of moving up to global mediocrity (higher wages, lower unemployment, better quality products and services). It's not good for countries whose median wages and quality of products and services are above the global average.

    So, I agree with you, John, that outsourcing, and the broader concept of globalization, contributes to the U.S. housing crisis because our standard of living is unsustainable given our movement towards a lower, world standard.

  11. Well, from what I am hearing, Congress has eliminated the $15,000 tax credit from the stimulus bill. I've been renting for 15 years and now it looks like I will continue to rent. This credit would have really helped me buy my first it is gone.

  12. According to the Wall Street Journal article on the conference committee compromise bill, it looks like the House version of the homebuyers credit survived. That is, first-time homebuyers would get up to a $7,500 refundable credit that would not require repayment.

    The House's homebuyers credit made the elimination of the 15-year payback effective on houses purchased starting January 1, 2009 and before July 1, 2009. Those first-time homebuyers who purchased their houses after April 8, 2008 through December 31, 2008 would still qualify for the credit, but will have to repay it over 15 years at $500/year starting on their 2010 tax returns.

    The Senate version also extended the purchasing period by two months to the end of August 2009. Whether this extended period stayed in the compromise bill is unclear.

  13. Housing values keeping falling, making borrowers underwater, destroying confidence, making paper on Wall Street toxic and banks in turn unwilling to lend. Declining housing values are the root of the economic crises. The $15,000 tax credit would've helped stabilize prices and warded off foreclosures by pushing buyers on the fence to purchase.

    Randy's column ignores the central problem and creates a ridiculous hypothetical with no basis in reality. Do you really think people are going to spend their time and money on attorneys, mortgages (they can't get) and related fees, closing costs, transfer taxes, surveys, UHaul and all the rest of the costs of buying and selling a home so they can house swap with someone in their neighborhood for the credit? They're not even going to break even assuming they had enough taxable income to take advantage of the credit to begin with.

  14. I was married in September of last year. We are currently looking for a new home. My husband qualifies as a 1st time home buyer, but I own a condo in another state. My name will not be on the new mortage or the deed, would he still qualify for the credit?

  15. Anonymous, I don't offer tax advice on this blog, but I will offer this bullet from the Form 5405 instructions regarding who qualifies:

    "You (and your spouse if married) did not own any other main home during the 3-year period ending on the date of purchase."

    This might be a grayer requirement than what it appears to be on the face of it. "Main home" means the place you lived most of the time. "You and your spouse" could be interpreted as "jointly owned," but that may not, in fact, be the intent of the law.

    You're talking about an $8,000 credit here. It would be worth seeking out a CPA to look carefully at the actual Internal Revenue Code rather than the boiled down instructions that come with the form.

    The form and instructions can be found at:


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