The Foreign Service Journal, January 2003

T here’s just about nothing worse than having to pay a hefty tax bill on the gain from the sale of a house in which you failed to reside in for two out of the last five years because you were serving overseas. AFSA has pushed for years to get this injustice to Foreign Service personnel rectified, and was on the verge of suc- cess with Congress in late 2002. [See box, p. 19.] A retroactive tax exclusion would be extraordinarily valuable, since it could enable Foreign Service employ- ees who sold their homes since 1997 without being able to qualify for the exclusion to claim potentially large tax refunds. FS personnel who do not currently qualify for the maximum exclusion, but who are nonetheless considering selling their homes on the basis of the impending legislative provision, may wish to delay selling until after the bill has been passed. But they should keep in mind that even if the 108th Congress passes the bill, it could drop the retroactive clause due to changing fiscal circum- stances. The good news is that if you have already sold your home, or must do so whether or not such legislation is enacted in the near future, there are several provisions in current law that can help you avoid paying tax on your gains, or at least reduce it. These provisions are described in IRS Publication 523, “Selling Your Home,” available at www.irs.gov. Perhaps the best-known aspect of the home-sale gain exclusion is the fact that married couples can exclude up to $500,000 in gain from their tax- able income. But married taxpayers must meet several conditions to qual- ify for this exclusion. First, a couple must file a joint return for the year in which the home sale occurs. Second, one or the other spouse must meet the ownership test — i.e., have owned the property for at least two years out of the five preceding the sale. Third, both spouses must meet the use test; that is, they must have lived in the house for two years out of the five preceding the sale. And, fourth, nei- ther the taxpayer nor his or her spouse can have excluded gain from the sale of another house during the two-year period ending on the date of the sale. Married couples who do not quali- fy for the full $500,000 exclusion because the two of them did not live in the house for at least two years out of the five preceding the sale can, nonetheless, avoid tax on up to $250,000 of gain if at least one mem- ber of the couple lived in the house for two years. The taxpayer or spouse must have lived in the house being sold for at least 730 days, but not nec- essarily during one continuous period; i.e., one year of residence, followed by a one-year tour overseas, and then another year of residence would qual- ify the taxpayer for the exclusion. Short absences during a period of res- idence, such as vacations or business trips, can be counted toward the peri- od of residence as long as the taxpay- er continues to maintain his or her home at that address. A Reduced Exclusion If the couple keeps records of their “basis” — the cost of the property and certain other expenses, as outlined in Pub. 523 (see Pub. 551, “Basis of Assets”, for more details) — they can minimize their tax bite even if they have a gain of more than $250,000 that is subject to taxation. They will be taxed only on the difference between the “basis” and the sales price, so the more documented expenses they add to their claimed “basis,” the less gain on which tax will be assessed. Another twist to the home sale gain exclusion is that the spouse who lived in the house must also have been on the title as an owner for two out of the five years preceding the sale, but not necessarily at the same time as he or she lived in it. Thus, a taxpayer can count a period of residency as a tenant in a property toward the use test, as long as he or she subsequently purchased the prop- erty and owned it for at least two years prior to the sale. Those who do not meet the two- 18 F O R E I G N S E R V I C E J O U R N A L / J A N U A R Y 2 0 0 3 Claiming the Tax Exclusion for Gain on Home Sales B Y E DWARD J. M ICHAL FS F INANCES There are several provisions in current law that can help you avoid paying tax on your gains, or at least reduce it.