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Home Buyer Tax Credit Fraught with Fraud

Am I surprised? No. Am I disappointed? Sure.

The first time home buyer tax credit, which has been credited with adding 355,000 home buyers to the market so far that would not have bought a home without it, and which is under heavy pressure on Capitol Hill to be extended and expanded past its Nov. 30 deadline, has been a haven for criminals.

What I thought would be a snoozer hearing in a House Ways and Means subcommittee this morning has incensed and amazed me. Testimony from the Hon. J. Russell George, Treasury Inspector General for Tax Administration, reports hundreds of millions of dollars, yep, your and my tax dollars, have been paid out to scam artists and just plain cheater buyers through the housing tax credit.

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Now don't get me wrong.

I am aware that our entire tax system is played by criminals as well as usually law-abiding citizens who just want to cheat themselves into a few extra dollars.

There's no way any tax credit could exist without some fraud, but what gets me here is the lack of foresight that the IRS showed in implementing at least some filters to rid this particular credit of the most audacious fraudsters.

Mr. George began his testimony, "I am very concerned by the findings of our audit in the states that are involved."

He then went on to enumerate the crimes:

74,000 claims filed by buyers who already own a home
Cost: $500 million

19,300 claims filed for homes that had not yet been purchased
Cost: $139 million

580 claims filed by "children," some as young as four years old
Cost: $4 million

Total so far: $643 million paid out in potentially fraudulent claims.

And don't forget, many many home buyers have not yet filed their returns.

So were some of these mistakes? Perhaps.

But Linda Stiff, Deputy Commissioner for Services and Enforcement at the IRS, testified before the same committee that "The IRS has already identified over 160 potential schemes resulting in scores of criminal investigations. We have also selected more than 100,000 returns for examination." She then told the committee that 8000 taxpayers are under "criminal investigation."

When asked buy a committee member if she thought the fraudulent claims might just be honest mistakes, she replied, "Based on what we've seen thus far, it's too early to weigh in."

Now here's what gets me. Mr. George told the committee:

"In a memorandum that TIGTA issued to the IRS on November 25, 2008, we recommended the IRS ensure that information on each line of the Form 5405 [the home buyer tax credit form] was transcribed for paper returns and that the information from the form be used to validate claims for the First-Time Homebuyer Credit. We also recommended the IRS require that taxpayers attach documentation to substantiate a home purchase in order to verify eligibility for the Credit. In a response to our memorandum, the IRS disagreed with both of TIGTA’s recommendations...the IRS considers the requirement to supply documentation burdensome..."

Until May of this year, the IRS did not have filters in place to identify whether or not those claiming the credit were in fact first time buyers. When Mr. George's people looked into that, they found the 74,000 taxpayers "had entered information on their individual income tax returns for one of the prior three years ...including deductions for home mortgage interest, real estate taxes, deductible points and qualified mortgage insurance premiums."

I'm thinking those are kind of hard to miss, when they're on the IRS's own forms!!

And even when the IRS implemented examination filters to identify erroneous claims in May of this year, "the age of the taxpayer receiving the Credit was not one of the specific filters implemented..." says Mr. George's report.

Once again, a no brainer there. Let the children of the world unite and buy U.S. homes!

Okay, now to be fair, Ms. Stiff launched a strong defense. The IRS was faced with implementing two different home buyer tax credits, one from the previous administration (a $7500 credit that had to be paid back) and one from the current administration ($8000 yours forever). Stiff enumerated various outreach and education programs that the IRS used and then added:

"Administering the FTHBC poses challenges similar to those the IRS confronts with other refundable credits --namely, it has a number of eligibility rules and the Federal government lacks third-party data sources which can be used to verify taxpayers' eligibility for the credit."

There is no question that the first time home buyer tax credit juiced the housing market in 2009. Almost 1.5 million buyers took advantage of it, and through the credit the government added nearly $10 billion in home purchasing power to a housing market that was on life support.

As we debate the pros and cons of an extended or expanded home buyer tax credit, we must scrutinize the filing process itself further and spend as much time debating the safeguards for said credit as we do its potential merits.

Questions? Comments? RealtyCheck@cnbc.com