The plunge in sales came despite the lowest mortgage interest rates in decades.
The housing report sent US stocks lower, with both the Dow Jones and Nasdaq averages down by roughly 1 per cent in mid-day trading on Tuesday.
Analysts had expected a steep decline: July was the first month that homebuyers could not qualify for an $8,000 tax credit. Lawrence Yun, the chief economist at the National Association of Realtors, said many buyers purchased homes before the deadline, causing the drop in demand.
"A soft sales pace likely will continue for a few additional months," Yun said.
Still, the slumping sales numbers raised concerns about the US economy, struggling to recover from a recession that was largely set off by a mortgage meltdown.
"The economy's absolutely not dead, but this is certainly not recovery," Max Fraad Wolff, an economist at the New School in New York, told Al Jazeera. "We're not going to go back to the high levels we saw in 2006 or 2007."
The housing numbers sent US government bonds soaring, a sign that investors are worried about a stalled economy. US government bonds are considered a safe place to invest when the broader economy is troubled.
'More to do'
The economy is a major political concern for Barack Obama, the US president, whose Democratic party faces a difficult midterm election in November. An Associated Press poll released last week found that only 41 per cent of Americans approved of Obama's handling of the economy, his lowest level of support yet.
The White House has sought to make this the "recovery summer": It launched a six-week campaign in June to promote its economic achievements, particularly the $787 billion economic stimulus package approved last year.
But the last few weeks have brought several grim economic reports.
The US labour department said last week that jobless claims had jumped to more than 500,000, their highest level since last winter. And earlier this month, the US commerce department announced that the country's trade deficit had surged to more than $49 billion. Exports fell by 1.3 per cent, their largest drop since April 2009.
More than 8 million were lost in the US during the recession.
Bill Burton, a White House spokesman, told reporters that Tuesday's housing numbers show "there's more to do" on the economy.