First time buyer tax incentive?

[simpletron]

It's not a free loan if maat works (which I believe he does). It is a loan with a 15% or 25% interest rate (federal) plus whatever bracket he is for his state the year after he takes the $7500. It's not free.

jim in 2010, you are going to earn X dollars and because you earned X dollars you will have to pay Y dollars in taxes. I don't know what X and Y are, but it doesn't matter. because if you took the 7500 credit/loan this year, you would owe Y+500 dollars in 2010. it doesn't matter if you earned nothing or a million.

at the federal level, the credit just shift current liability to later years.

Most states would tax the $7500 refund you received the previous year. So there is state tax owed on the money too. If you use the credit to actually invest, it would be cheaper to just invest the $500/mo for 15 years than to take the credit.

I doubt any state could tax it, do you owe more to the state just because you claim a federal tax credit? so you would owe less to the state if you didn't take the federal child tax credit, right? even if it is taxed at the state level, it still is capped at 10% only once at the begining. to overcome the 10% initial loss, you would need to earn an after tax return of ~1% over the the next fifteen years, which is a piece of cake to do. anything above that would be a profit.

was my earlier post ingored? to add to this, for 500/year for 15 years to beat 6750 initially, the after tax retrun has to be UNDER 1.5%/year. if the state does tax it, then instead of a 0% loan, treat it as a <1% loan.

if you qualify, the only people who shouldn't take it are the ones who will spend it instead of "refinancing" debt, putting into savings, or investing because it should be treated as very low interest debt.

[TBH]

Information on the newer version which is up to $15,000 tax credit that you do not pay back. As of now, it looks like it will pass, but you never know.

The $15,000 Home Buying Tax Credit: 6 Things to Know - The Home Front (usnews.com)

Thanks for this, GT. We are almost definitely buying a house within the next few months, so I have been looking for info about this.

[jIM_Ohio]

at the federal level, the credit just shift current liability to later years.

was my earlier post ingored? to add to this, for 500/year for 15 years to beat 6750 initially, the after tax retrun has to be UNDER 1.5%/year. if the state does tax it, then instead of a 0% loan, treat it as a <1% loan.

if you qualify, the only people who shouldn't take it are the ones who will spend it instead of "refinancing" debt, putting into savings, or investing because it should be treated as very low interest debt.

Not ignored. You missed the whole point.

I agree you are getting $7500 now to pay back in $500 increments later.

The $7500 would be taxed as income by the state because that is income to you in current year. If you don't do this, then don't complain to me when your state tax bill gets labeled as past due. Federal refunds are taxable to the state. State refunds are taxable to the federal return (if you itemized and took a deduction for state taxes paid).

The $500 you are paying later is money in your checking account. More than likely you earned the money, so you paid taxes on that money to get it there. If you banked the $7500 and pay it back in $500 increments, keeping the interest (which would also be taxed), the probability you come out ahead in this interest rate environment is little.

Examples
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I bank $7500, put it in a CD earning 2%. Each year I take out $500 from savings to repay fed.

After 15 years the checking account has $1476. With inflation of 4.8%, that would be worth half what it is today ($748 of purchasing power).

I would owe taxes of $221 (15% bracket) or $369 (25% bracket) on the interest earned.

Plus I would owe state taxes on the $7500 federal refund (4%= $300; 6%=$450). on an absolute dollar basis (no inflation), the interest earned in either case ($1476) is reduced byabout $800, giving a net $600 return.
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If you needed to spend the money (the $7500) the taxes get even worse. You receive $7500 from fed. You pay the same state tax above on the refund (between $300-$450). You need to earn either 22.65% (15% bracket) over this or 32.65% (25% bracket) above this to pay the appropriate SS, medicare and fed income taxes on this money. Add in state income taxes (2-6%) on that percentage.

Meaning to get $500 in my checking account I need to earn $613 (15% bracket) or $663.25 (25% bracket) to get that money in my account to pay the fed back. Over 15 years that is $9195 (15% bracket) in earnings to pay back $7500. No thanks. In 25% bracket that is $9948 to pay back $7500.

The idea of using the credit for emergencies does not make sense to me.

[simpletron]

I currently live in a state where there is no personal income tax, so I don't have to worry about most of this stuff.

let's assume the state treats the tax credit as "additional income" when you take it and therefore is taxed. when you pay it back, wouldn't that be treated as a "loss of income" and therefore you would get a deduction. if this is true, then there would be no net increase in state taxes assuming the tax rate doesn't change. also in this case, a future increase in the tax rate would cause a net decline in state taxes and vice versa.

so you prove that by taking the credit, you would still come out ahead even in this pitiful saving rate enviroment. $600 net is still $600 dollars in my pocket that I wouldn't have if i didn't take the credit. do you think that interest on savings is going to average less that 2% over the next 15 years? even the ten year treasury is doing better than that.

if you spent the credit, the taxes you describe are no different from what you would pay if you took out a loan, spent the money, and then paid off the loan. I completely agree that you shouldn't increase your spending because of the credit.

for a true emergency and you had no money, wouldn't it be better to borrow the money at low interest rate like the tax credit over borrowing from credit cards or loans at a significantly higher rate?

[jIM_Ohio]

I currently live in a state where there is no personal income tax, so I don't have to worry about most of this stuff.

let's assume the state treats the tax credit as "additional income" when you take it and therefore is taxed. when you pay it back, wouldn't that be treated as a "loss of income" and therefore you would get a deduction. if this is true, then there would be no net increase in state taxes assuming the tax rate doesn't change. also in this case, a future increase in the tax rate would cause a net decline in state taxes and vice versa.

so you prove that by taking the credit, you would still come out ahead even in this pitiful saving rate enviroment. $600 net is still $600 dollars in my pocket that I wouldn't have if i didn't take the credit. do you think that interest on savings is going to average less that 2% over the next 15 years? even the ten year treasury is doing better than that.

if you spent the credit, the taxes you describe are no different from what you would pay if you took out a loan, spent the money, and then paid off the loan. I completely agree that you shouldn't increase your spending because of the credit.

for a true emergency and you had no money, wouldn't it be better to borrow the money at low interest rate like the tax credit over borrowing from credit cards or loans at a significantly higher rate?

simpletron- That $600 is net over a 15 year period. Inflation will probably cut that in half. The risk adusted return on that $600 is too low (high risk, low return). There is too much variance in tax brackets over a 15 year period for me to be confident this makes sense (to get only $600).

There is a better way- assuming anyone which takes this credit already has the house (purchased prior year), just keep deducting the house expenses and lowering the taxes paid. Then bank those refunds- that is exactly what I am doing. If I was renting at same cost as my mortgage, no way could I afford to max Roth IRA for self and spouse, no way could I save 25% of my gross pay.

Instead of earning more money to pay the credit back, just invest the $500/year (probably 1% of pay for someone making 50k) into 401k... you save on the taxes and it will be more efficient (higher returns, tax shelter, tax bracket is probably higher in year 15 than year the credit would have been taken).

$600 over 15 years to my bottom line is not worth the risk of repaying the IRS something.

[simpletron]

simpletron- That $600 is net over a 15 year period. Inflation will probably cut that in half. The risk adusted return on that $600 is too low (high risk, low return). There is too much variance in tax brackets over a 15 year period for me to be confident this makes sense (to get only $600).

why does inflation matter? just because it doesn't buy as much as it does now, doesn't change the fact that $600 will buy something more than I would have otherwise.

where is the high risk; are you scare that you would lose money just saving the credit? it is possible to lose money, but odds are low. let's say you average 3% over the next fifteen years. I find this is a conservative estimate given the fact that you can find 1,2,3,4,5 years CD at or above 3% that and the 10 treasury is currently close to 3% with no state taxes. so you can lock in a 3%+ for a lot of the years and also I doubt rates will go much lower. now let's take one of the worst tax situation, you owe extra 10%(750) upfront to the state and your marginal tax rate is 45%(35% federal +10% state). also your marginal tax rate increases every year by 3%, so during the last year your marginal tax rate is 90%. after all that you would still make 7 bucks. also you can buy municipal bonds to avoid taxes.

if you're worried about not making much and don't need liquidity, then "refinancing" debt is also a good plan. since they just bought a house, they more than likely have a mortgage at 5-6%. a 7500 prepayment will save an extra 4542.81 in interest on a 5% mortgage over paying a extra 500/year. you lose some tax deduction, but still ahead by ~3400(25%) or ~3900(15%). credit card debt and other loans for even higher possible returns. is this also a high risk, low reward plan?

Instead of earning more money to pay the credit back, just invest the $500/year (probably 1% of pay for someone making 50k) into 401k... you save on the taxes and it will be more efficient (higher returns, tax shelter, tax bracket is probably higher in year 15 than year the credit would have been taken).

if you are going to have $500/year to invest in a 401K, why not invest it now? change the amount going to the 401K now and take decrease in pay from the cash, the credit gives you. for most people, it would take less than 2 years to convert the entire 7500 into a 401K. at 8% return, you'll earn an extra ~8K and at 10%, an extra 12K. there is the good possibility that you won't save as much on the taxes, thus decreasing the advantage of this plan(1500 for an average increase of 20% in tax rates). also the 500/year can win before the difference in taxes, if either the stock market tanks again to lower levels in the next couple of years or there is flat to negative growth over the 15 years. I find that both of these have a fairly low possibility of occurring. but this is definitely a high risk, high reward plan.

[jIM_Ohio]

why does inflation matter? just because it doesn't buy as much as it does now, doesn't change the fact that $600 will buy something more than I would have otherwise.

where is the high risk; are you scare that you would lose money just saving the credit? it is possible to lose money, but odds are low. let's say you average 3% over the next fifteen years. I find this is a conservative estimate given the fact that you can find 1,2,3,4,5 years CD at or above 3% that and the 10 treasury is currently close to 3% with no state taxes. so you can lock in a 3%+ for a lot of the years and also I doubt rates will go much lower. now let's take one of the worst tax situation, you owe extra 10%(750) upfront to the state and your marginal tax rate is 45%(35% federal +10% state). also your marginal tax rate increases every year by 3%, so during the last year your marginal tax rate is 90%. after all that you would still make 7 bucks. also you can buy municipal bonds to avoid taxes.

if you're worried about not making much and don't need liquidity, then "refinancing" debt is also a good plan. since they just bought a house, they more than likely have a mortgage at 5-6%. a 7500 prepayment will save an extra 4542.81 in interest on a 5% mortgage over paying a extra 500/year. you lose some tax deduction, but still ahead by ~3400(25%) or ~3900(15%). credit card debt and other loans for even higher possible returns. is this also a high risk, low reward plan?

If you tie up the money in more than a 1 year CD or in a treasury, you immediately fall into the second example I listed where you need to earn more than $500 to pay back the credit because the money is tied up in a CD which has an early withdraw penalty (unless you ladder the $7500 into 15 $500 CDs with maturity dates between 1-5 years you would have this issue -IMO).

The risk I speak of is tax risk- the risk for me that my taxes will go up in future (because of increased income, loss of deductions or increase in bracket tax percentage). Most home owners would find this to be true (because mortgage interest paid decreases each year) as a generalization (not true in all cases- I know).

[jIM_Ohio]

if you are going to have $500/year to invest in a 401K, why not invest it now? change the amount going to the 401K now and take decrease in pay from the cash, the credit gives you. for most people, it would take less than 2 years to convert the entire 7500 into a 401K. at 8% return, you'll earn an extra ~8K and at 10%, an extra 12K. there is the good possibility that you won't save as much on the taxes, thus decreasing the advantage of this plan(1500 for an average increase of 20% in tax rates). also the 500/year can win before the difference in taxes, if either the stock market tanks again to lower levels in the next couple of years or there is flat to negative growth over the 15 years. I find that both of these have a fairly low possibility of occurring. but this is definitely a high risk, high reward plan.

You are taking my replies out of context. If someone has to EARN money to pay the credit back (because they spent the $7500), it is MUCH more efficient to put the $500 into a 401k (and save $75 or $125 in taxes) than to earn $625 or $575 to pay the $500 back.

My point was if the plan was to spend the $7500 then pay it back with earnings... they are better off (tax wise) to NOT take the credit and increase 401k by $500 per year.

[simpletron]

If you tie up the money in more than a 1 year CD or in a treasury, you immediately fall into the second example I listed where you need to earn more than $500 to pay back the credit because the money is tied up in a CD which has an early withdraw penalty (unless you ladder the $7500 into 15 $500 CDs with maturity dates between 1-5 years you would have this issue -IMO).

The risk I speak of is tax risk- the risk for me that my taxes will go up in future (because of increased income, loss of deductions or increase in bracket tax percentage). Most home owners would find this to be true (because mortgage interest paid decreases each year) as a generalization (not true in all cases- I know).

I was trying to show that under one of the worse conditions(low interest + high taxes) is a break even endeavor. so that if you earn a higher interest rate and/or lower taxes, you would make money.

for interest rate of 3%, I thinking along the lines of putting 500 each into 1 , 2, 3, and 4 year cds, 2500 into a 5 year and 3000 into 10 year treasury, all of which effectively more earn 3%(because of high state taxes i will assume). so this gives you 3%+ for the 1, 2, 3, 4, 5,and 10th payments, first 5 years of 6, 7, 8, 9th payment, and first 10 years of 11. 12. 13. 14. 15th payments. for the remaining interest I assumed that you would earn 3% or more. I can assume this given the strong correlation between federal funds rate at .25% and cd rates. since the federal funds rate can't really go lower, so cd rates can really go much lower.

for taxes, I took the worst current tax situation and then increase it quite quickly. since the 1920's, there has only one period of time has a greater change(up or down) and that was 1930ish to 1945ish where the top tax rate went from ~25% to 80-94%, also nothing else is close. for the 10% upfront to state, i assume it would be paid out of the fund and you would lose all interest associated with it. to claim the full credit, they must earn under 150K, so they would have to more double their income the next year to fall under the current worse tax. so I highly doubt anyone would experience something as bad or worse than this. if the taxes do get out of hand there are tax-exempt interest and you only need a 1.25% interest rate to break even.(unfortunately the easy ways to do this are currently yielding too low, but the hard ways as are yielding high enough.)

side note about federal funds and cd rate:
there are not directly related. their relationship is more like two blocks with a spring in the middle. as you push or pull the federal funds block, the cd block resist the change but eventually moves with federal funds' will. aslo the cd block can over shoot the change.

[simpletron]

You are taking my replies out of context. If someone has to EARN money to pay the credit back (because they spent the $7500), it is MUCH more efficient to put the $500 into a 401k (and save $75 or $125 in taxes) than to earn $625 or $575 to pay the $500 back.

My point was if the plan was to spend the $7500 then pay it back with earnings... they are better off (tax wise) to NOT take the credit and increase 401k by $500 per year.

what I was saying was put the money in 401K now, which gives you a tax deduction now. versus putting into later and get a tax deduction later. I agree with the fact that they are probably better off tax wise by not taking the credit. because a large tax deduction now is more likely to cause a drop in brackets, also there is fact that most people tend to move up the brackets as they age, and then there is my thinking that taxes rates are just going to go up. if you want to remove this disadvantage then do the whole thing in a roth 401K(currently ~30% of 401K plans has this option).

but the potential earnings of plan can still outwiegh the tax disadvantage. the average case is you earning around 10K more with paying 1-3K more in taxes which sounds like pretty good deal. but there is also the scenario where you earn 4K less and paying 3K more in taxes (double wammy). under great depression bad(falling stock market, rising taxes), you would lose around 20K net and under the 80s/90s good(rising stock market, falling taxes), you could gain over 50K net.(these last two are rough estimates)

this isn't a low risk plan at all. this plan also doesn't produce chump change result unlike saving or refinancing and can cause significant changes in your long term plans for the better or worse. the odds are in favor of you coming out ahead, but just because that is true doesn't make you a winner.