First-Time Homebuyer Credit & NOL Carryback Update
On Nov. 6, 2009, President Obama signed the “Worker, Homeownership, and Business Assistance Act of 2009” (the “2009 Assistance Act” or the “Act”), which enhanced the provisions regarding net operating losses (NOLs) and the first-time homebuyer tax credit. These enhancements can potentially result in significant income tax refunds for eligible taxpayers. The following is an in-depth review of both provisions.
Net Operating Losses (NOLs)
Background
A net operating loss (NOL) is the excess of business deductions (computed with certain modifications) over gross income in a particular tax year. The loss can be deducted, through an NOL carryback or carryover, in another tax year in which gross income exceeds business deductions. In general, NOLs may be carried back two years and forward 20 years. The NOL is first carried back to the earliest tax year for which it's allowable as a carryback or a carryover, and is then carried to the next earliest tax year. A taxpayer may elect to forego the entire carryback period for an NOL and instead carry it forward.
Stimulus legislation passed earlier this year allowed eligible small businesses (with average annual gross receipts of $15 million or less for 2006-2008) to elect to carry back NOLs from 2008 for 3, 4 or 5 years rather than the standard 2 years. A taxpayer with a fiscal year (i.e., other than a calendar year) was entitled to choose the extended carryback period for the tax year that began or ended in 2008.
New Law
The 2009 Assistance Act provides an election for most taxpayers (not just small businesses) to increase the carryback period for an applicable NOL to 3, 4, or 5 years from 2 years; however, taxpayers that have received or will receive financial assistance under the Emergency Economic Stabilization Act of 2008 in the form of an equity infusion or acquisition of a warrant (or other right) are not eligible to make an election.
An applicable NOL means the taxpayer's NOL for any tax year ending after Dec. 31, 2007, and beginning before Jan. 1, 2010. This means the election may be made for a tax year beginning or ending in either 2008 or 2009.
Losses carried back 2, 3, or 4 years can be used to offset 100% of taxable income; however, a special provision of the Act provides that taxpayers electing a 5-year carryback can offset only 50% of the available taxable income for the 5th tax year preceding the loss year. Unlike previous versions of this proposal which were not included in the final legislation, there is no “haircut” for the amount by which the NOL is limited in the 5th preceding year. The amount of the NOL otherwise carried to tax years after the 5th preceding tax year is adjusted to take into account that the NOL could offset only 50% of the taxable income for the 5th year. For certain taxpayers, the 50% limitation on 5-year carrybacks can actually be beneficial because it can allow them to avoid using the NOL carryback to offset Year 5 taxable income that is taxable at lower marginal tax rates.
In addition, for alternative tax NOLs attributable to carrybacks for which the extended carryback is elected. the Act suspends the 90% limitation on the use of an NOL deduction for alternative minimum tax purposes.
Making the Election
Taxpayers generally can elect an extended carryback period under the 2009 Assistance Act for only one tax year (generally either 2008 or 2009); however, small businesses that have already elected an extended carryback for a 2008 NOL under the prior stimulus legislation may still elect an extended carryback for 2009 NOLs.
The election of an extended carryback period must be made by the due date (with extensions) for filing the tax return for the taxpayer's last tax year beginning in 2009. Once made, the election is irrevocable. If the taxpayer had previously elected to forego the carryback of an NOL from a tax year ending before Nov. 6, 2009, the taxpayer may revoke that election before the due date (including extensions) for filing the taxpayer's 2009 return.
Optimizing the Value of an NOL Carryback
Determining the carryback period that will result in the greatest income tax refund requires careful analysis. The general rule is that the loss should be carried back to the taxable year with the highest marginal tax rate. It is important to note that this is not necessarily the taxable year with the highest taxable income.
|
Taxable Income
(TI) |
Portion of TI taxable at the 15% long-term capital gain rate |
2004 |
$1,500,000 |
$750,000 |
2005 |
$1,500,000 |
$-0- |
2006 |
$500,000 |
$-0- |
2007 |
$-0- |
$-0- |
2008 |
($500,000) |
$-0- |
For example, consider a taxpayer who has a $500,000 NOL in 2009. The taxpayer’s taxable income for each of the following 5 taxable yIt is important to note that, absent the new legislation, the taxpayer would not be able to utilize its 2009 NOL to obtain a refund of prior taxes. This is because the taxpayer did not have any taxable income in the standard 2-year carryback period (2007 – 2008).
Assuming that the taxpayer had already carried back the $500,000 loss from 2008 to 2006, the taxpayer will need to determine whether the $500,000 NOL from 2009 should be carried back to 2004 or 2005. If the taxpayer elects to carry the loss back to 2005, the value of the refund will be $75,000 ($500,000 X 15% long-term capital gain rate). If the taxpayer elects to carry the refund back to 2006, the value of the refund increases to almost $175,000. Despite the higher taxable income in 2005, a carryback to 2006 is more valuable because it is offsetting income that is taxed at the higher, ordinary income tax rates (up to 35%).
In addition to considering the impact of the long-term capital gain tax rate on the value of the NOL, taxpayers must consider the potential interaction of the alternative minimum tax. Even though 100% of the AMT taxable income can be offset by a carryback election under the Act, in many instances, the amount of the alternative minimum tax (AMT) NOL may be different – and usually smaller -- than the amount of the regular tax NOL. Due to this and several other intricacies, the AMT can significantly reduce the value of the carryback refund.
Because the value of a carryback refund can differ significantly for each carryback year and because it is almost impossible to guestimate the value of the refund, it is recommended that both the regular and the AMT tax liabilities be recalculated for each year in the available carryback period to determine the optimal carryback election.
First-Time Homebuyer Tax Credit
Background
Before the 2009 Assistance Act was enacted, the homebuyer credit was only available for qualifying first-time home purchases after April 8, 2008, and before December 1, 2009. The maximum amount of the credit for homes bought in 2009 is $8,000 ($4,000 for a married individual filing separately) or 10% of the residence's purchase price, whichever is less.
The credit is available for the purchase of a principal residence (i.e., a main home) located in the U.S. Vacation homes and rental properties are not eligible.
The homebuyer credit reduces a taxpayer’s tax liability on a dollar-for-dollar basis. If the credit exceeds the amount of the tax liability, the excess credit will be refunded to the taxpayer.
For homes bought after December 31, 2008, taxpayers must pay back the homebuyer credit if they dispose of the home or stop using it as their principal residence within 36 months of purchase.
The credit is subject to a phase-out based on modified adjusted gross income (AGI) for the year of purchase. Before the new law, the credit was phased out at modified AGI between $75,000 and $95,000 ($150,000 and $170,000 for joint filers).
Taxpayers who qualify for the 2009 credit can either amend their 2008 tax return to claim the credit or claim the credit on their 2009 tax return. Claiming the 2009 credit on an amended tax return for 2008 allows taxpayers to request an immediate refund of the credit amount (instead of having to wait until their 2009 tax return can be filed). In either case, the credit cannot be claimed until the taxpayer has finalized the purchase of the home.
New Law
The 2009 Assistance Act makes four important changes to the homebuyer credit, the first three of which make the credit easier to claim:
Extended Purchase Period
The Act extends the deadline for purchasing the residence from November 30, 2009 to April 30, 2010. The Act also permits the credit for be claimed with respect to a principal residence bought before July 1, 2010 by a person who enters into a written binding contract before May 1, 2010, to close on the purchase of the principal residence before July 1, 2010.
In general, a home is considered bought for credit purposes when the closing takes place. So the extra two months (May and June of 2010) help buyers who find a home they like but can't close on it before May 1, 2010. They can go to contract on the home before May 1, 2010, close on it before July 1, 2010, and get the homebuyer credit (if they otherwise qualify).
Certain service members on extended duty outside of the U.S. get an extra year to buy a qualifying home and get the credit and can avoid the recapture rules under certain circumstances.
Credit Available to Long-Term Homeowners
For purchases after November 6, 2009, taxpayers can claim the homebuyer credit if they (and, if married, their spouse) maintained the same principal residence for any period of five consecutive years during the eight years ending on the date that a new principal residence is purchased.
Taxpayers don't have to sell their existing home in order to qualify for a homebuyer credit on the replacement home. They can purchase the replacement home first (in order to satisfy the July 1, 2010 closing deadline explained above) before they sell their old home, or they can hold on to their old home in the hope of achieving a better selling price later on. However, they must use the replacement home as their principal residence.
The maximum allowable homebuyer credit for qualifying existing homeowners is $6,500 ($3,250 for a married individual filing separately), or 10% of the purchase price of the subsequent principal residence, whichever is less.
The Homebuyer Credit Is Available To Higher-Income Taxpayers
For purchases after November 6, 2009, the homebuyer credit phases out over higher levels of modified AGI, making the credit available to a bigger pool of buyers. For individuals, the phase-out range (previously between $75,000 and $95,000) is increased to between $125,000 and $145,000, and for those filing a joint return, it's increased to between $225,000 and $245,000 (previously between $150,000 and $170,000).
$800,000 Ceiling on New Home Purchase Price
One of the most unfavorable provisions of the new homebuyer credit rules is the imposition of an $800,000 ceiling on the purchase price of the residence, which applies to purchases after November 6, 2009. It's important to note that there is no phase-out mechanism. A purchase price that exceeds the $800,000 threshold by even a single dollar will cause the loss of the entire credit. The new purchase price limitation applies whether taxpayers are buying a first-time principal residence or are long-time homeowners purchasing a replacement principal residence.
Anti-Abuse Rules
The Act includes a number of new anti-abuse rules that make it tougher to claim the homebuyer credit. The most important of these are as follows:
- Beginning with the 2009 tax return, the homebuyer credit can't be claimed unless the taxpayer attaches to the return a properly executed copy of the settlement statement used to complete the purchase of the qualifying residence.
- For purchases after November 6, 2009, the homebuyer credit can't be claimed unless the taxpayer is at least 18 years old as of the date of purchase. A married person is treated as meeting this requirement if he or his spouse is at least 18 years old. For purchases after November 6, 2009, the homebuyer credit can't be claimed by a taxpayer who can be claimed as a dependent by another taxpayer for the tax year of purchase.
- For purchases after November 6, 2009, the homebuyer credit cannot be claimed for a home purchased from a person related to the homebuyer or his or her spouse.
For further information regarding either net operating losses or the first-time homebuyer tax credit, please contact Natalie Takacs at (800) 229-1099 or ntakacs@cohenflorida.com. |
