Amassing 10 to 20 percent of a purchase price for a down payment is a steep barrier to home ownership for first time home buyers. The Washington Post reports that real estate agents see a steady decline in first-time and young home buyers in the market. This year, the Virginia General Assembly created a new estate planning tool to ease the tax burden on families facing this hurdle. On July 1, 2014, the Virginia First Time Home Buyer Savings Plans Act went into effect, creating favorable tax treatment for funds set aside for down payments on a home. The Washington Post describes this new tool as a college savings plan for first time home purchases.
I do not believe that this will become immediately popular. Its use will likely be limited to families with sufficient wealth to have the flexibility to set aside funds under this statute. As written, it will do little to open the door of home ownership to working families.
The Basics. Under the Act, savers are not required to set up depository accounts like Health Saving Accounts or Individual Retirement Accounts. Instead, they use a state tax return form to claim the favorable tax treatment on ordinary bank accounts. Designated funds must be used solely for the down payment and closing costs for the purchase of a single-family residence in Virginia. The residence can be a single-family dwelling, townhouse, condominium unit, co-operative, trailer or manufactured home. The beneficiaries of the designated account must be bona-fide first-time home buyers. Families may designate up to $50,000 in principal and enjoy state tax-free growth up to $150,000.00. These figures seem bullish about the potential investment performance of these accounts. Unfortunately, a $50,000 down payment is not much for buyers to work with in many real estate markets in Virginia.
State Tax Exempt Growth. The benefit of the program is that designated accounts enjoy growth exempt from state income tax until the funds are used. Note that this law does not necessarily affect federal income tax treatment.
Penalties for Unqualified Use. If funds are used from designated accounts for purposes other than qualified purchases, the transfer is subject to a 5% penalty plus a recapture of subtracted income. The only exemptions are for: (a) death (b) disability, (c) bankruptcy or (d) transfers to an account for another qualified beneficiary. Unfortunately, families who are struggling to set aside money for first time home purchases also face other financial challenges. For many people, down payment savings also acts as an emergency fund to cover expenses in the event of job loss, pregnancy, etc. Once funds are designed to this new plan, they cannot be used for such purposes unless they fit within an exemption. For many people, this loss of flexibility may outweigh the state tax savings. On the plus side, the penalty may help some people save by discouraging them from using the funds for impulse purchases.
Estate Planning Tool. The Act has in mind parents and grandparents who are interested in setting aside funds for future first-time home purchases in Virginia by their children and grandchildren. Note that the funds may only be used to purchase homes in Virginia, not other states. The Act requires the first-time home buyer to live in the home after purchase. It is not clear how long a purchaser would need to live in the home to avoid a tax penalty. This restriction is an impediment for beneficiaries who are drawn to other states or countries for work, education, family or heath reasons.
Ironically, the First-Time Home Buyer Savings Plan may give wealthy families an advantage in the real estate market because they may have sufficient funds to designate accounts under the Act, leaving other assets unrestricted. Families unable to take advantage of this new law will not enjoy the state tax-exempt growth. That said, new options present opportunities to creative people. Perhaps creative estate planning professionals will find ways of using this Act to help their clients achieve their goals within the context of their unique circumstances. Consult qualified tax and estate planning advisors prior to using this new tool.