First time homebuyer--purchase from relative

[origun]

My client rents to her daughter and spouse. She would like to sell the home to them in 2009 (before Dec) so they could get the first time homebuyer credit. Can they claim the credit if they purchase from a relative if they meet all of the other criteria? Does it matter if the mother carries the contract or if they get a traditional mortgage?

[Koss]

Related Person

This is gonna get really complicated really fast, 'cause my reading of the law brings me to a somewhat surprising conclusion.

I'll take the easy part first:

Doesn't matter how the home is financed. Cash sale, land contract, seller-financed mortgage, traditional mortgage, whatever. Whether the buyer gets a loan, and who the lender is, has no impact whatsoever.

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Edited at 2:15 AM on 03/27/09:
Okay, wait a minute... you can't take the homebuyer credit if the financing comes from tax-exempt mortgage revenue bonds. Never say never, and never say always. It's obviously incorrect to say that it "doesn't matter how the home is financed." But this goofy exception is clearly not relevant to your original question. The seller could be the lender.
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Now for the weird part:

You can't take the credit if you buy the house from a related person. For purposes of the first-time homebuyer credit, this term is defined by modifying the definition of related party that is found IRC 267 and IRC 707(b). Those code sections disallow a capital loss when the sale involves a related party. The definition used in those sections encompasses a range of biological relationships, and some really kinky stuff that is not applicable to your client's fact pattern, such as selling an asset to a partnership in which your spouse is a partner, or selling something to a trust in which you are a beneficiary.

For your clients, the relevant part of the definition flatly disallows the homebuyer credit if the home is purchased from the taxpayer's spouse, ancestors, and lineal descendants.

So if your client sells the house to her daughter, the credit will be disallowed.

But it appears that your client could sell the house to her son-in-law. In other words, don't put the daughter on the deed or the mortgage note.

And while I have to admit that this sounds counterintuitive, I don't see anything in the code that would prohibit the couple from claiming the entire $8000 credit, on a joint return, even though only one spouse--the one that isn't related to the seller--has purchased the home.

The code defines "first-time homebuyer" as a taxpayer, and his/her spouse, if married, who hasn't owned a principal residence within the last three years. So both spouses are eligible for the credit, and that's what matters. If one spouse actually owned a home within the last three years, then both are disqualified from claiming the credit, even if they file separately. Filing status has no bearing on eligibility. If you file MFS, the amount of the credit is cut in half, but filing MFS doesn't change the definition of who is eligible.

So as a married couple, they appear to be eligible, as long as you can say that neither one of them has owned a home in the last three years, and as long as you can say that the buyer is not related to the seller. If the wife isn't buying the house, then the purchase appears to qualify for the full $8000 credit, assuming they file a joint return...

The best analogy I can come up with is a foster child, who has been placed by the court into the custody of one spouse, but not the other. Say, for example, that Tommy's parents are killed in a crash, and Taxpayer Susie Q. becomes Tommy's guardian, because Tommy's mother was Susie's sister. The court order naming Susie as Tommy's guardian makes no mention of Susie's husband. If Susie and her husband decide to file separately, only Susie can claim Tommy as a qualifying child. Tommy is not a qualifying child for Susie's husband, because the relationship test is not met. But if they file a joint return, they both benefit from the dependent exemption and the child tax credit... that's all there is to it.

Not a perfect analogy, but I really think this his how the homebuyer credit works.

BMK



Afterthought: The real problem with the foster child analogy is that for Susie's husband, the qualifying child relationship test IS met, because even without the guardianship, the kid is his nephew by way of marriage... To make this analogy work right, I think you gotta make the kid Susie's cousin.

[origun]

Interesting--and a follow-up question

Thanks for taking your time to write such a thorough and clearly expressed answer.

A thought...if mom should sell to son-in-law, I wonder how long before the son-in-law could "sell" half of the property to his wife.

And in the case of my clients, the son-in-law isn't in good health...so the daughter would probably inherit at some time.

[Koss]

Subsequent sale or transfer

You wrote:

A thought...if mom should sell to son-in-law, I wonder how long before the son-in-law could "sell" half of the property to his wife.

And in the case of my clients, the son-in-law isn't in good health...so the daughter would probably inherit at some time.

They might not have to wait long at all...

I wouldn't do it the next day, and I certainly wouldn't try to do it all at once at one big happy closing in order to save money on the fees charged by the title agency. If they do it too quickly, and the IRS examines the return, the initial sale from the mother to her son-in-law might be construed as a sham based on the "economic substance" argument.

And he might not need to "sell" half the house to his wife. Six months later, or whatever time frame they choose, they could probably just go to a lawyer and add her name to the deed. That transaction would be treated as a gift from him to his wife, of an undivided one-half interest.

The irony is that after you claim the credit, you lose it, or you have to pay it back all at once, if you sell the house to an unrelated party too soon. The code doesn't seem to prohibit me from buying a house, taking the credit, and then nine months later literally selling the house, at its true FMV in an arms-length transaction... to my brother. But if I sell it to an unrelated person, I have to give back the credit. In other words, I can't buy the house, take the credit, and then flip it. But selling it to a family member is not construed that way.

You gotta be a little careful about how strongly you recommend the sale from the mother to the son-in-law. It varies from state to state, but when a married couple buys a house, there are many factors that have to be taken into consideration when they decide how the property will be deeded. So if you do anything other than explain the tax implications, you may be crossing into the practice of law.

But with that being said, in most states this is not going to be an issue. They need to discuss it with an attorney. But there may not be any compelling reason NOT to deed the house to the husband only, in order to take the credit. They just need to have a proper estate plan in place, especially if he's not in good health.

For example... the son-in-law could probably take title to the house in a revocable living trust, because that's a disregarded entity. Or maybe all he needs is a simple will to make sure that his wife gets the house. You just gotta be a little careful about how you position this, because if it's not done right, and the law of unintended consequences kicks in, it becomes a train wreck. Like, what if he dies without a will, and has a kid from some previous relationship? Recipe for disaster.

BMK

[Koss]

Further thoughts

I hope to high heaven you're not in a community property state, 'cause that might change the whole equation.

Apart from that, I think the real analogy to how this credit is structured, at least for your question, might be the exclusion of gain on the sale of your principal residence.

Married couple lives in the home for ten years and then sells it at a gain. Assume that all criteria are met to qualify the house and the couple to exclude the gain. Now further assume that the house was owned only by the husband and not by the wife.

If they file a joint return, they still get the full $250K exclusion, even though her name wasn't on the deed...

Right?

By the way... the code section that authorizes the homebuyer credit defines principal residence by reference to the definition used in the code section that authorizes the exclusion of gain on the sale of your main home.

BMK

[origun]

Not a community property state

I am in Oregon--not a community property state. I will not make any recommendations...but only a suggestion of a possibility that she might want to discuss with a lawyer.

Thanks so much for your input and the time you spent responding!