The arithmetic is short and the ceiling is the trap. Section 25(a)(1) allows a credit equal to the product of the certificate credit rate and "the interest paid or accrued by the taxpayer during the taxable year on the remaining principal of the certified indebtedness amount". Section 25(a)(2)(A) then adds that "if the certificate credit rate exceeds 20 percent, the amount of the credit allowed to the taxpayer under paragraph (1) for any taxable year shall not exceed $2,000". That ceiling is conditional, not universal, and it produces a counterintuitive result: at a high enough interest figure a 20 percent certificate is worth more than a 30 percent one, because only the second is capped. Where two or more people hold interests in the residence, 25(a)(2)(B) allocates the cap among them in proportion to their interests. The $2,000 carries no indexing clause anywhere in the section, so it is the same figure it has been since the credit was enacted.
The rate is set locally, inside a federal band. Section 25(d)(1) says the certificate credit rate "shall not be less than 10 percent or more than 50 percent", and nothing in federal law picks a number inside that range. The issuing agency does, which is why two certificates from two states can carry very different rates and why a national "typical MCC rate" does not exist.
The issuer pays for the program by giving up something. Under 25(c)(2)(A) the program must be established by a state or political subdivision for a year in which it is authorized to issue qualified mortgage bonds, and the authority must elect "not to issue an amount of private activity bonds which it may otherwise issue during such calendar year". That forgone amount is the nonissued bond amount, and 25(d)(2) caps the program: the sum of each certificate's indebtedness amount times its credit rate may not exceed 25 percent of it. So the size of a state's MCC program is bounded by bond authority it chose not to use, which is why MCC allocations run out and why a program can be open one year and closed the next.
The eligibility tests are borrowed from the bond rules. Section 25(c)(2)(A)(iii) requires the certified indebtedness to meet the residence, three-year, purchase price, income and targeted-area requirements of section 143, the same tests that govern tax-exempt mortgage revenue bonds. Two further conditions matter to a borrower: 25(c)(2)(A)(iv) bars a certificate on a residence any of whose financing came from proceeds of qualified mortgage bonds or qualified veterans' mortgage bonds, so the two subsidies cannot be stacked on one house; and 25(c)(2)(A)(vi) provides that, except as regulations allow, the certificate is not transferable.
The credit and the deduction do not stack. Section 163(g) provides that the mortgage interest deduction "shall be reduced by the amount of the credit allowable with respect to such interest under section 25 (determined without regard to section 26)". Form 8396 says the same thing in plainer words: "You must reduce your deduction for home mortgage interest on Schedule A (Form 1040) by the amount on line 3." The parenthetical in 163(g) is doing real work. Section 26 is the tax-liability limitation, so the deduction is reduced by the credit the certificate produces even in a year when a small tax bill means the taxpayer cannot use all of it.
Unused credit is not lost immediately. Section 25(e)(1) carries an excess over the applicable tax limit forward "to each of the 3 succeeding taxable years", subject to a stacking rule in (B) that uses older carryforwards first. Form 8396's Part II is where that bookkeeping happens, and the credit itself reaches the return through Schedule 3.
The certificate has a life, and it can end before the loan does. Under 25(e)(3)(A) a certificate is in effect from the date it is issued until the earlier of revocation by the issuing authority or the date "the residence to which such certificate relates ceases to be the principal residence of the individual to whom the certificate relates". Converting the home to a rental ends the credit. A refinance does not automatically end it either: 25(e)(4) authorizes regulations under which an administrator may reissue a certificate against the replacement loan, on terms ensuring the reissued credit is no larger than the original would have been.
Selling early can cost part of the subsidy back. Section 25(i) points to section 143(m), which increases the tax of a taxpayer who disposes of an interest in the residence by the lesser of a recapture amount or "50 percent of the gain (if any) on the disposition". Two exceptions sit at 143(m)(2): a disposition by reason of death, and any disposition more than nine years after the testing date. The recapture amount itself is the product of three figures: a federally-subsidized amount equal to 6.25 percent of the highest principal the taxpayer was liable for, a holding period percentage that rises from 20 in the first year to 100 in the fifth and falls back to 20 in the ninth, and an income percentage. The shape is worth knowing even without the arithmetic: the exposure peaks in year five, disappears after year nine, and can never exceed half the gain, so a sale at a loss triggers nothing.
