A 4-year-old …? How does a 4-year-old get approved for an $8,000 first-time homebuyer tax credit?

While Realtors, lenders, appraisers, home inspectors, escrow officers and every other professional service connected to home sales and financing are lobbying for an extension of the first-time homebuyer housing credit, a recent audit revealed thousands of fraudulent claims and a need for more safeguards to support the popular program.

It’s disheartening that problems would surface in the one plan that is housing’s primary driver, but I guess the fraud disclosure should not come as a surprise. Mortgage scams have been in the news. And, we are just now getting an indication of how many consumers are willing to participate — especially if they think there is a chance the Internal Revenue Service will not discover their creative maneuvers.

The American Recovery and Reinvestment Act of 2009 revised and extended the first-time homebuyer credit provided for in the Housing and Economic Recovery Act of 2008 to Nov. 30, 2009. Taxpayers qualifying for the program may claim the $8,000 credit on either their tax year 2008 or 2009 individual income tax returns. As of July 17, 2009, more than 1.1 million tax returns claiming more than $8 billion had been processed.

The goal of the recent audit conducted by the Treasury Inspector General for Tax Administration (TIGTA) was to determine whether the IRS had controls in place that effectively identified erroneous claims for the tax credit.

It developed computer programs to identify 73,799 first-time homebuyer credits attached to an original U.S. Individual Income Tax Return (Form 1040), totaling almost $504 million, that were claimed by taxpayers who had indications of prior homeownership within the last three years.

According to the audit, the 73,799 taxpayers had entered information on their individual income tax returns for one of the prior three years indicating they may have owned a home. These entries included deductions for home mortgage interest, real estate taxes, deductible points, and qualified mortgage insurance premiums.

While the IRS adopted controls to identify many questionable claims for the credit, some key controls were missing, according to the TIGTA. Missing from the suggested safeguards was information provided on the First-Time Homebuyer Credit (Form 5405) to verify eligibility requirements. In addition, taxpayers were not required to provide documentation that they actually purchased a home.

The law defines a "first-time homebuyer" as any individual (and spouse, if married) who had no ownership interest in a principal residence during the three-year period prior to the purchase of the home to which the credit applies.

According to the audit summary, TIGTA identified 19,351 tax year 2008 electronically filed tax returns on which taxpayers claimed credits totaling more than $139 million for homes that had not yet been purchased. …CONTINUED

If that revelation wasn’t absolutely mind-boggling, then the discovery of 4-year-old claimants (apparently more than one) really takes the cake. In the words of the audit writers: "Through July 25, 2009, we identified 582 taxpayers under 18 years of age who claimed almost $4 million in first-time homebuyer credits. The youngest taxpayers receiving the credit were 4 years old.

"Contract law generally exempts children under the age of 18 from being bound by the terms of a contract. Therefore, it is unlikely that these taxpayers would have entered into an arm’s-length transaction for the purchase of a home."

Approximately 28 percent of the 582 taxpayers under age 18 that were identified claiming the credit did not meet the IRS’ Adjusted Gross Income screening criteria. In 64 of these cases, other IRS filters flagged the claim for further scrutiny. However, 101 of the claims (totaling $626,779) made by children under the age of 18 did not meet any of the IRS screening criteria.

As of May 17, 2009, the IRS implemented examination filters to identify potentially erroneous claims for the credit. The age of the taxpayer receiving the credit was not one of the specific filters implemented by the IRS to screen the original claims. According to the audit, the IRS believed that its filter identifying taxpayers claiming the credit who had adjusted gross incomes below certain levels would catch the questionable claims.

Also falling through the cracks were 12,023 taxpayers claiming to be first-time homebuyers who had taken a residential energy tax credit within the past three years.

"This increases the likelihood that the taxpayers owned a principal residence and do not qualify for the First-Time Homebuyer Credit since this credit is generally only available for qualified expenditures made on a taxpayer’s principal residence …"

While many taxpayers will be identified by recently implemented IRS filters and are subject to pre-refund audits, the TIGTA identified 70,005 taxpayers whose tax returns were processed prior to the implementation of the filters.

Clearly, the IRS underestimated the need for basic first-time homebuyer safeguards in the credit program — and probably the popularity of the program itself.

But a 4-year-old?

Tom Kelly’s book "Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border" was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com.

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