THE AMERICAN HOUSING Rescue and Foreclosure Prevention Act of 2008 (the Housing Act) was signed into law on July 30. The new legislation is supposed to stem the tide of home foreclosures and provide a lifeline to floundering mortgage lenders. It also includes three federal income tax changes that will affect many individuals. Two are intended to be helpful, but the third is meant to hurt. Here's what you need to know about all three.

1. Temporary New Home Buyer Tax Credit Isn't as Good as Advertised

Congress wants you to believe the new tax credit of up to $7,500 for qualified buyers of principal residences is a really terrific break. Not so fast. Here's the truth:

The maximum credit equals the lesser of: (1) 10% of the home purchase price, or (2) $7,500 ($3,750 if you're married and file separately from your spouse). The credit is refundable. That means you can use it to offset your entire regular federal income tax liability plus receive the difference from Uncle Sam should the credit exceed your tax bill.

The credit is generally available for a principal residence purchased after April 8, 2008, and before July 1, 2009. However, you're only eligible if you have not owned a principal residence in the U.S. during the three-year period that ends on the purchase date. If married, your spouse must pass this test too. You also can't buy the home from your spouse, an ancestor (parent, grandparent, and so on), or a lineal descendant (child, grandchild, and so on). If you build a new home, the purchase date is considered to be the day you move in.

If you make a qualified home next year (before the July 1, 2009 deadline), you can opt to pretend the transaction happened in 2008 and claim a credit on this year's Form 1040. That will get the money to you a lot quicker. Otherwise, you can claim the credit for a 2009 purchase on next year's Form 1040, which you won't be able to file until sometime in 2010.

Fair enough. Now for the things Congress hopes you're too dumb to remember by election time.

It's Phased Out for "High-Income" Types
The credit is phased out or completely eliminated if your adjusted gross income (AGI) is "too high."

* The phase-out range for unmarried individuals and married folks who file separately is between AGI of $75,000 and $95,000. For example, say you're single with 2008 AGI of $90,000. If you buy a principal residence between now and year-end, the phase-out rule would reduce your credit by 75% to only $1,875 [$7,500 - ($15,000/$20,000 x $7,500) = $1,875].

* The phase-out range for married joint filers is between AGI of $150,000 and $170,000. For example, if your AGI is $170,000 or higher, there's no credit for you.

You Gotta Repay It
Finally here's the real gem the new credit is really just a loan from the feds. You have to repay it (without interest) over 15 years starting with the second year after the year you claim the credit.

For example, say you bag the maximum $7,500 credit for a 2008 home purchase. In 2010, you'll have to repay $500 ($7,500/15 = $500) with that year's Form 1040 and then continue the repayment drill through 2024 (unless you die first). If you sell the home or stop using it as your principal residence before repaying the credit, you'll generally have to cough up the unpaid balance with your Form 1040 for the year when that happens.

Now wait a minute! Wasn't the whole foreclosure mess caused by too many people borrowing too much money? Doesn't this new credit (which is really only a disguised loan) just add to the problem? No wonder Congress has a 19% approval rating! Your average citizen couldn't come up with anything this stupid.

2. Temporary New Property Tax Deduction for Nonitemizers

For 2008 only, an unmarried person who doesn't itemize deductions can add up to $500 of state and local real property taxes to the normal standard deduction amount. Ditto if you're married and file separately from your spouse. If you're a married joint filer, you can add up to $1,000. However, you can't add more state and local taxes than you actually pay.

Counting the addition for property taxes, the maximum 2008 standard deduction figures will generally be as follows (elderly and blind individuals are entitled to larger amounts):

* $5,950 for single filing status.

* $8,500 for head of household filing status.

* $11,900 for married filing joint status.

* $5,950 for married filing separate status.

Obviously, this break is not a big deal, but at least you don't have to pay it back!

3. Bigger Tax Hit on Properties Converted Into Principal Residences

Until now, you could convert a former rental property or vacation home into your principal residence, live in it for at least two years, sell it, and qualify for the federal home sale gain exclusion. The maximum exclusion is $250,000 for unmarried individuals and $500,000 for married joint filers. The Housing Act throws some cold water on this tax-saving scheme by punishing you for post-2008 periods when the property is not used as your principal residence. Here's how the punishment works.

Example:

Say you bought a very nice vacation home on 1/1/05. On 1/1/11, you convert it into your principal residence, live in it for two years, and sell it on 1/1/13 for a sweet $500,000 profit. Your total ownership period is eight years, but the two years of post-2008 use as a vacation home (2009 and 2010) count against you. Specifically, the two years result in a nonexcludable gain of $125,000 (2/8 x $500,000 = $125,000). So you'll have to report the $125,000 as capital gain on your 2013 Schedule D and pay the resulting federal income tax hit. If you're a married joint filer eligible for the $500,000 exclusion, you won't have to pay any federal tax on the remaining $375,000 of gain ($500,000 - $125,000) because it's completely sheltered by your exclusion. If you did the same deal today, however, you wouldn't owe a dime to the IRS.

While this change probably won't hurt real estate prices very much, it sure won't help. Thanks, Congress! Keep up the good work!

Corrected on Aug. 5, 2008:
The original story stated that the new home buyer tax credit cannot be used to reduce the AMT. It can be used to reduce the AMT.

Also See:
A Primer on Homeowner Tax Breaks
Taxes When You Sell Your Home at a Loss
5 Mortgage Fees to Watch Out For