Painfully, I see it every day. Realtors, “investors”, property management firms and individual owners all falsely marketing in online ads that prospective tenants can get the First Time Home Buyer Tax Credit on a lease option or lease purchase transaction. Sadly, from a legal perspective, this is completely untrue. Lease option and lease purchase contracts are NOT considered to be bona fide sales and do NOT qualify a buyer for the First Time Home Buyer Tax Credit of $8,000. Don’t let anyone else tell you otherwise and if they do, steer them to the IRS website and point them to IRS PUB 537. The IRS has very easy, but very strict guidelines on what legally passes muster on an owner finance transaction that would qualify a tenant or buyer for the $8,000 tax credit. Rent to own contracts do not qualify!
Here’s a quick snapshot of the requirements from a buyer’s perspective when engaging in a Rent To Own deal to qualify for the tax credit:
From the Buyer’s Perspective
- Individual income must not have exceeded $125,000 in the tax year for which the credit is claimed if filing individually or $225,000 combined if married filing jointly. If it exceeds these limits, you may still qualify but for a lesser amount. There is a specific formula for this to determine the amount. One key thing to remember is that this is based off of your MAGI, or modified adjusted gross income, not the actual number that shows as your income on your W-2 because this does not take into account itemized deductions that you have that effectively reduce your taxable income and provide you with your AGI, or adjusted gross income.
- Must not have owned AND lived in a primary residence in the prior 36 months for the $8000 credit or must have owned and lived in a primary residence for the last 60 months for the $6500 credit
- Must not be buying the property from an immediate relative
- Must use a contract that is in compliance with the IRS Installment Sales Contract Guidelines (contract for deed, land contract or installment sales contract)
- Must file an IRS Form 5405 with your return or amended return
- Must enter a binding contract BEFORE May 1st, 2010. This doesn’t mean you have to take occupancy on that date. It simply means that you have to execute a contract and make it a legal contract by paying what is called “good and valuable consideration” (in other words, money).
- Home purchase price cannot exceed $800,000
That’s pretty much it. Thankfully, other than the formulas for calculating your MAGI, it is very simple (which is an oxymoron when discussing anything developed by the IRS).
The key here is caveat emptor, which means, “let the buyer beware”. Beware of false advertising and people looking to make a quick buck while putting you at risk of a tax audit and re-payment of the tax credit plus penalties and interest. In many cases they will recover this by garnishing your wages or sweeping funds from your bank account when you least expect it. Believe me, I know. I have been audited and been through the additional pleasures of wage levies, wage garnishments and having my bank accounts swept without warning leaving me with zero funds (which then causes bounced checks , charges and a host of other problems).
Because of my prior fun with the IRS, I wanted to ensure that our clients were fully protected and not at risk of losing an audit due to our contract structure.
When I developed our Contract for Deed contracts, I consulted with a client who is a partner in the largest independent business advisory firm in Georgia with more than 385 CPAs to ensure that we were in complete bulletproof compliance. He brought in his partner at the firm who has more than 26 years of experience in real estate taxation who then confirmed that we were doing things correctly so that our clients could not only claim the federal and state tax credits, but could also legally deduct their new housing payments just like home owners with mortgages do.
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