Will Your State Government Help You Save a Down Payment?

Will Your State Government Help You Save a Down Payment?

Depending on where you live, the answer is “maybe.” Several states have created tax-deferred savings plans to help first-time buyers save up down payments.

Each state that has established a tax-free first-time home buyer savings account allows the money from the account to be used for a down payment and all eligible closing costs associated with buying a home. All participating states provide that if the money is used for non-qualified purposes, any taxes escaped by that portion of the account must be paid, plus a penalty.

If you live in a state that allows you (or someone gifting you the money) to deduct the contribution to the down payment savings account, it’s a no-brainer. Your down payment is made from pre-tax income, and never taxed.

With some exceptions, all states require that the funds be used to purchase a home within the state. Some states have deadlines, others don’t.

So far states have followed one of two different models. One model encourages larger savings accounts but limits the tax benefits, and the other offers greater tax benefits but uses much lower limits on how much can be saved. Let’s take a look:

Which States Offer Down Payment Savings Accounts?

As of today, states that offer first-time home buyer savings accounts include Colorado, Iowa, Minnesota, Mississippi, Montana and Wyoming.

Colorado, Minnesota and Virginia follow the higher balance model.

Colorado’s bill was signed into law in June 2016. Money can be deposited into a designated first-time home buyer savings account either by a prospective first-time home buyer, or by other individuals who designate a first-time home buyer as the beneficiary. Either way, the income deposited is still taxed, but interest earned on the account is not taxed, assuming it is used for a qualified purpose.

Any individual may deposit up to $14,000 in an account, but multiple individuals can deposit up to $50,000 on behalf of a single designated home buyer. The money from the account may be applied to a down payment and eligible closing costs. The buyer must buy the property in Colorado.

Penalties will be charged for withdrawal for other purposes – 5 to 10 percent, depending on how long the account has been open. However, there is no time limit on how long the account may remain in place before it is used.

Virginia’s law is essentially the same, except there are no annual contribution limits. However, no single account may retain more than $50,000, and in aggregate no more than $150,000 may be kept in multiple accounts.

Minnesota is similar to Virginia, except no more than $150,000 may be kept in any one account. There is no limit on the number of accounts, however.

Iowa, Mississippi and Montana follow the other model.

In Iowa the amount contributed to the account is tax deductible, in addition to the interest earned. Iowa limits the amount of the qualified deduction to $2,000 for an individual and $4,000 for a married couple – substantially less than Colorado and Virginia. (But they are indexed for inflation.)

The funds must be used within ten years of establishing the account. After ten years the tax benefit reverses and the funds (both deposits and earnings) are taxed if not used to purchase a home. Funds withdrawn for a non-qualified purpose are subject to a 10 percent penalty as well. The highest state income tax rate in Iowa is 8.98 percent. If you withdraw the funds for a non-qualified purpose, you pay more than twice what you would have paid if you hadn’t established the account, therefore, since you pay the state income tax plus a 10 percent penalty!

Mississippi’s law mirrors Iowa’s, except contributions are limited to $2,500 per individual, rather than $2,000.

Montana’s law mirrors that of Iowa and Mississippi, except contributions are limited to $3,000 per individual.

New York has passed a similar law, but it has not been signed by the governor yet. Alabama, Louisiana, Michigan, Missouri, Pennsylvania and Oregon are all reportedly considering similar laws.

Is A Tax-Free Down Payment Savings Plan Right For You?

If you live in a state that allows you (or someone gifting you the money) to deduct the contribution to the down payment savings account, it’s a no-brainer. Your down payment is made from pre-tax income, and never taxed.

If you live in a state that only allows the interest you earn on the account to be tax-free, then be certain that you are going to use the money as planned, or you’ll pay more in the end for having created the account than never having done so. However, the longer you have the accounts, the greater the benefit, and if there is no time limit for using the money, eventually you will probably reap the benefits of the account.

For state-specific details, visit these sites:

Colorado

Iowa

Minnesota

Mississippi

Montana

Virginia


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