When it comes to housing, it's a buyer's market -- especially for first-time home buyers eligible for new tax breaks.

The American Housing Rescue and Foreclosure Prevention Act of 2008, passed by Congress at the end of July with hopes of shoring up the ailing housing market, also includes an important tax break. First-time home buyers who purchase a home after April 8, 2008, and before July 1, 2009, are eligible for a $7,500 tax credit (or, if the home costs less than $75,000, a credit equal to 10% of the purchase price).

This credit, however, comes with a catch. You'll have to pay it back.

Here's the good part: The credit reduces your tax liability on a dollar-for-dollar basis and can even boost your refund. If you owe $10,000 in taxes, you can take the credit and pay just $2,500. Or if you owe $5,000 in taxes and have paid it over the year, you can take the credit and receive all your money back with an additional $2,500.

But unlike other federal tax credits, the new credit must be paid back to the government over a period of 15 years.

Income Limits

"It's the equivalent of an interest-free loan from the government," says Bob Trinz, senior tax analyst at the tax and accounting business of Thomson Reuters.

To qualify for the credit, you (and if married, your spouse) must not have owned a principal residence during the three-year period before you buy the home. In general, the credit is available in full only if your adjusted gross income doesn't exceed $75,000 ($150,000 if you file a joint return).

The credit phases out over the $150,000 to $170,000 adjusted gross income range for joint filers ($75,000 to $95,000 for individual filers).

If you claim a $7,500 credit, you'll have to start paying it back as an extra tax amount on your federal returns at the rate of $500 per year, beginning with the tax return for the second year after you buy the new home. That is, if you buy a home this year and claim the credit, you'll have to start paying back the money when you file your 2010 return in 2011.

For more details and examples of how the new law works, visit the Web site of Congress's Joint Committee on Taxation at www.jct.gov and look for publication JCX-63-08 on the home page. For additional information on tax breaks from the Internal Revenue Service, see Publication 530 at irs.gov.

IRA Withdrawals

Another option for first-time home buyers is to take out money from your traditional individual retirement account (IRA) or from your Roth IRA.

Typically, if you take money out of a traditional IRA before age 59½, you pay a 10% early withdrawal penalty. But you can avoid that penalty if neither you nor your spouse has owned a home in the previous two years. You can receive distributions from your traditional IRA to pay up to $10,000 of first-time home buyer expenses, but "because you still have to pay taxes on the withdrawal...it's not a particularly attractive way to fund a down payment on a home," says Kaye Thomas, a tax lawyer and tax-guide publisher in Lisle, Ill.

With a Roth IRA, a withdrawal from contributions is always tax and penalty free. If you have held your Roth IRA for five years, and plan to use the money to finance your first home, you can withdraw from both earnings and contributions with no financial repercussions.

Write to Shelly Banjo at shelly.banjo@wsj.com

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