First-Time Home Buyer Tax Credit: All Sorts of Sketchy Claims

Federal officials have identified more than $600 million in questionable credits.

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Since the Obama administration enacted it in mid February, the first-time home buyer tax credit has been immensely popular with Americans brave enough to jump into the battered real estate market. But now, it appears the tax perk may have become too popular. Using computer programs and other means, a Treasury Department inspector general has identified more than 90,000 cases totaling more than $600 million questionable first-time home buyer tax claims, while flagging shortcomings in Internal Revenue Service controls. In one extreme case, at least one 4-year-old received the credit. The IRS, meanwhile, has uncovered 167 criminal schemes, launched 115 criminal investigations, and frozen more than 110,000 refunds pending examinations. "There are possibly hundreds of millions of dollars that have been paid to taxpayers who are not entitled to the credit," Rep. John Lewis, a Georgia Democrat, said during a Congressional subcommittee hearing Thursday. "We want to, and we need to, stop this fraud and abuse." Here are five things to know about the development.

[Check out New Home Buyer Tax Credit: 7 Things You Need to Know]

1. First-time home buyer tax credit: In an effort to stimulate housing demand, President Obama included a tax credit for certain first-time home buyers in the $787 billion economic stimulus package he signed into law in mid-February. Under the terms of the legislation, anyone who hasn't owned a primary residence in the past three years and earned less than a specific income threshold—$75,000 for individuals, $150,000 for married couples—is eligible for a tax credit of up to $8,000 if they bought a primary residence on or after Jan. 1, 2009, and before Dec. 1, 2009. The new perk expanded a similar, less-generous home buyer tax credit that had been established in the Housing and Economic Recovery Act of 2008. Through Aug. 22, more than 1.4 million taxpayers have claimed one of these two credits. That's about $10 billion of lost revenue for Uncle Sam.

[See Why Obama's Housing Rescue Hasn't Prevented Record Foreclosures]

2. Claiming before buying: Taxpayers must purchase a home before they can claim the credit. However, the Treasury inspector general found more than 19,300 electronically filed tax returns—totaling nearly $140 million—where taxpayers claimed the credit before having actually purchased a home. (And since the inspector general hasn't finished reviewing the paper filings, the total figure could in fact be much higher.) In November of 2008, the inspector general recommended that the IRS require anyone claiming the credit to produce documents to verify their eligibility and substantiate the purchase. "The IRS…stated that a requirement to supply documentation with the tax return would be burdensome for both the taxpayer and the IRS," Russell George, the Treasury's inspector general for tax administration, said in prepared testimony. "Had the IRS timely implemented our recommendations…these claims would not have been paid."

[See Will the $8,000 First-Time Home Buyer Tax Credit Be Extended?]

3. Previous ownership: Only those who have not owned a primary residence within the past three years are eligible to claim the credit. However, the inspector general found nearly 74,000 cases—totaling credits of more than $500 million—of taxpayers claiming the credit even though their tax returns indicated that they might have been homeowners within the past three years. Some taxpayers who claimed the first-time home buyer credit also took deductions for real estate taxes, home mortgage interest, points or mortgage insurance. Since these deductions could have been claimed on second homes, they don't—by themselves—prove that the filers wrongly claimed the first-time home buyer tax credit, the inspector general said. "However, we believe they warrant scrutiny by the IRS."

4. Underage buyers: In addition, the inspector general found that more than 580 taxpayers younger than 18 years old—including at least one who was just four—had claimed the first-time home buyer tax credit. These claims total nearly $4 million. "Contract law generally exempts children under the age of 18 from being bound by the terms of a contract," the inspector general said. "Therefore, it is unlikely that these taxpayers would have entered into an arm’s-length transaction for the purchase of a home."

5. Political price: The news comes as trade groups step up their efforts to rally support for extending the tax credit's deadline, which is set to expire at the end of November. While the tax perk is credited with having juiced home sales in recent months, some experts question whether another big outlay of federal cash—during a time of trillion-dollar deficits—is really the best use of government resources. These reports of potential erroneous claims offer wonderful ammunition to political forces looking to prevent the tax credit's extension. You'll be hearing plenty more about this as the debate heats up.