Many first-time homebuyers may be unaware of the Sec. 25 mortgage interest credit, which is designed to help low- to middle-income families afford the cost of homeownership. Taxpayers who qualify for the credit can claim it on their federal income tax return for a portion of the mortgage interest they pay.
To receive a mortgage interest credit, a taxpayer must have been issued a mortgage credit certificate (MCC). MCCs are issued by a state or local government agency in the taxpayer's state of residence that is authorized to issue qualified mortgage bonds (see Secs. 25(c) and 143) but instead has elected to issue MCCs through an MCC program in lieu of some or all of the qualified mortgage bonds the agency is authorized to issue. MCCs can be issued for debt incurred as a qualified home improvement loan or a qualified rehabilitation loan, but, generally, they are only issued in connection with a new mortgage for the purchase of a taxpayer's principal residence.
To qualify for an MCC, besides being required to use the home as a principal residence, the taxpayer also must be a first-time homebuyer (someone who has not had an ownership interest in a principal residence in the previous three years, with some exceptions — see Sec. 143(d)(2)), meet certain income and sales price limits (which vary by state), and, in some states, complete some type of pre-purchase homebuyer education.
An MCC is generally available to those seeking a conventional, Federal Housing Administration, Veterans Affairs, or U.S. Department of Agriculture loan.
How the credit is calculated
The MCC provides two important amounts used in the calculation of a taxpayer's mortgage interest credit: the certificate credit rate (CCR) and the certified indebtedness amount. The CCR is a percentage used to calculate the taxpayer's MCC. The minimum CCR that an MCC may provide is 10%, and the maximum is 50%. The certified indebtedness amount is the amount of the taxpayer's mortgage loan covered by the MCC. Only interest on this amount qualifies for the credit.
The mortgage interest credit for a tax year is calculated (on Form 8396, Mortgage Interest Credit) by multiplying the mortgage interest the taxpayer paid or accrued for the tax year on the certified indebtedness amount. However, two limits may apply in calculating a taxpayer's mortgage interest credit. The first limit is based on the taxpayer's CCR. If the CCR is more than 20%, the maximum allowable credit for a tax year is $2,000.
The second limit applies based on the taxpayer's tax liability. The taxpayer's total mortgage interest credit for each year is limited to the "applicable tax limit," which is:
- The taxpayer's regular income tax liability reduced by the foreign tax credit and the alternative minimum tax; less
- The sum of the allowable nonrefundable personal tax credits, excluding the mortgage interest credit, the adoption expense credit, and the residential energy-efficient property credit.
The Credit Limit Worksheet in the Form 8396 instructions can be used to calculate the limit based on the taxpayer's tax liability. As discussed below, the excess of the credit over this limit can be carried forward.
Example 1: A married couple purchase a home and obtain a mortgage in the amount of $200,000, with a 10-year term of equal monthly payments and a fixed 4% annual interest rate. The couple receive an MCC with a CCR of 30% from their state housing agency. The couple pay interest during the first year equaling $7,698. The interest paid multiplied by the CCR ($7,698 × 30%) is $2,309, but their mortgage interest credit is limited to $2,000 because their CCR is over 20%.
Carryforward of unused credit
Any mortgage interest credit in excess of the applicable tax limit can be carried forward for three years. However, if the taxpayer is subject to the $2,000 limit due to the CCR being over 20%, the amount of the credit above $2,000 cannot be carried forward.
Example 2: Assume the same facts as in the previous example, except that the couple's CCR is 20% and their applicable tax limit is $1,300. The mortgage interest credit equals the interest paid multiplied by the CCR ($7,698 × 20%), which is $1,540. The $240 excess of the credit available over the applicable tax limit of $1,300 is carried forward to the next year.
Reduction of mortgage interest deduction
The credit can be claimed throughout the life of the loan, but the credit received must reduce any amount of mortgage interest deducted on Schedule A, Itemized Deductions, of Form 1040, U.S. Individual Income Tax Return. However, this will likely affect only a small number of taxpayers because most taxpayers claiming the credit also will be claiming the standard deduction instead of itemizing, due to the increase in the standard deduction made by the law known as the Tax Cuts and Jobs Act, P.L. 115-97.
The credit may be subject to recapture if the taxpayer disposes of the residence. The maximum recapture amount is the lesser of 6.25% of the highest principal amount of the mortgage loan for which the taxpayer was liable or 50% of the gain on the sale of the home. Agencies that issue MCCs report that most taxpayers who receive MCCs and take mortgage interest credits are not subject to recapture, and some agencies with MCC programs will reimburse taxpayers if they incur recapture tax.
The maximum recapture amount is adjusted if the taxpayer disposes of the residence within nine years of a testing date (the earlier of when the mortgage is federally subsidized or the taxpayer is liable in whole or in part for its payment). If the residence is sold after the nine-year testing period, none of the credit is subject to recapture. However, if the residence is sold during the nine-year testing period, the recapture amount can be further reduced or eliminated if the taxpayer does not make significantly more income in the year of disposition than in the year of purchase, or the taxpayer does not realize a gain on the sale of the home (Sec. 143(m)). A taxpayer performs the somewhat complicated calculation of the recapture amount on Form 8828, Recapture of Federal Mortgage Subsidy.
Don't leave money on the table
Based on the potential tax credits and the limited reach of the recapture rules, qualifying taxpayers should take advantage of the mortgage interest credit. As the example shows, a taxpayer who qualifies but does not apply for the credit could be leaving a significant amount of money on the table.
To find out more about the mortgage interest credit and how it is administered, homebuyers should contact their state or local government housing agency authorized to issue MCCs.
— Travis Wheeler, CPA, M. Acc., is a manager at Rudd & Co. PLLC in Rexburg, Idaho.
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