Federal Subsidy Recapture: Meaning, Formula, Exemptions

What Is a Federal Subsidy Recapture?

The term federal subsidy recapture refers to the repayment of all or part of a federal mortgage subsidy if the home is sold or otherwise disposed of within nine years of receiving a federally subsidized loan. If a home is financed using a federally subsidized program, then all or part of the benefit received from the program may need to be recaptured or repaid by increasing the federal income tax for the year of the sale.

How Federal Subsidy Recaptures Work

Purchasing a home is a dream for many people, but it can be very daunting because of how much a person needs to invest. That’s why programs that offer mortgage subsidies are in place. These are offered at various levels, including federally, to help make homeownership more affordable and accessible—especially for people with low incomes. Mortgage subsidy programs usually involve more lenient underwriting requirements and are normally only available to first-time homebuyers.

Federal mortgage subsidies occur when a homebuyer receives one or more of the following:

• A mortgage loan with a lower interest rate because it was funded from a tax-exempt qualified mortgage (QMB) issue, which is a type of mortgage bond,
• A mortgage credit certificate (MCC) with the mortgage loan that can be used to reduce the homebuyer’s federal income taxes
• An assumed seller’s obligation on a QMB-funded loan—provided that the homebuyer is qualified to obtain a loan from the proceeds of a QMB
• The seller’s MCC is transferred with the approval of the issuer, and the homebuyer meets the eligibility requirements for the MCC

Homeowners must abide by the terms and conditions of all mortgage subsidy programs to retain the benefits. So, if a borrower sells or disposes of their home after a certain period of time, all subsidies provided by the federal program(s) must be repaid. In most cases, the period of time is nine years. This is known as a federal subsidy recapture.

Federal Subsidy Recapture Formula & Calculation

The calculation that is used to work out federal subsidy recapture is complex. The Internal Revenue Service (IRS) provides instructions on how to do this in the instructions for Form 8828, which also details the special rules that apply to the calculation.

For most people, federal subsidy recapture is calculated by assessing the sale price of the home, the amount of interest or equity that the homeowner has in the residence, and other factors such as how much time passed between the close of the mortgage and the later sale of the house, as well as whether the federally subsidized loan was paid off in full within four years of the closing.

Here’s how the calculation is made:

1. The “Adjusted Qualifying Income” is calculated by taking the highest federal family income at the date when the mortgage was taken out. This is then multiplied by 1.05 to the nth power, where n is the number of full years that the property has been held.
2. Next, look up the holding period percentage, according to the number of years that the property has been owned—this increases from 20% in the first year to 100% in year five, then decreases again.
3. Then, the maximum recapture amount is calculated. This is 6.25% multiplied by the original principal amount of the mortgage multiplied by the holding period percentage.
4. No recapture is due if a mortgage holder has an income below a threshold value. To calculate this adjusted income, take the borrower’s gross income for the taxable year when the sale occurred and subtract the federal threshold income divided by 5,000.
5. Next, calculate the adjusted recapture amount, which is the maximum recapture (from above) multiplied by the income percentage (also from above).
6. The final recapture amount is either the adjusted recapture amount or 50% of the gain realized on the sale—whichever is lower.

However, calculations for individual recapture levels can be more complex than this outline, so you are advised to look up your state housing finance agency to access further resources on calculating your own federal subsidy recapture amount.

Federal Subsidy Recapture Exemptions

Some exemptions apply to federal subsidy recaptures. For instance, no recapture is necessary if the home is transferred due to the death of the homeowner.

Likewise, if the home is transferred from one spouse to the other during a divorce, the subsidy recapture does not go into effect. However, if the now ex-spouse sells the home within the nine-year period, they may be subject to a recapture tax. When calculating the tax, those who receive a home—or an interest in one—through a divorce will have an adjusted basis that generally will be the same as their former spouses.

If the home is sold after the nine-year period, then the federal subsidy is exempt from recapture. The same principle applies if the home is sold at no gain. Furthermore, if the homeowner’s income falls within limits set by federal guidelines, they are also exempt from recapture. If the home was given away within the nine-year period, then the possible tax through recapture must be calculated as if the home was sold at the fair market price at the time of sale.

The Bottom Line

Payment subsidies can help make buying a house possible for low-income borrowers struggling to purchase a home. That said, there are rules about repaying the subsidy if you sell the home within a certain period after closing or no longer live in the home. However, there are some exemptions, so check your state laws to learn if federal subsidy recapture applies to your situation.