The Foreign Service Journal, January-February 2015

58 JANUARY FEBRUARY 2015 | THE FOREIGN SERVICE JOURNAL TAX WITHHOLDING WHEN ASSIGNED DOMESTICALLY The State Department has instituted new procedures to comply with U.S. Treasury regula- tions for withholding state taxes for all employees serving domestically. (See Department Notice 2014_11_016, dated Nov. 3, 2014.) As a general rule, state taxes will be withheld for an employee’s “regular place of duty”— in other words your ocial duty station. Those employees for whom the Controller General of Financial Services has identified state tax inconsistencies were notified late in 2014. Bear in mind that this does not mean that you must relinquish your state of domicile, if it is dierent than your ocial duty station. “Domicile” (legal residence) is dierent from “residence” and so long as you maintain your ties to your home state you will be able to change your withholdings, if you so wish, back to your home state when you go overseas again. See the Overseas Briefing Center’s guide to Residence and Domicile, available on AFSA’s website at www.afsa.org/domicile. Bear in mind, too, that CGFS will not adjudicate state income tax elections when you are serving overseas, since in those circumstances it is the employee’s responsibility to accurately elect state income taxes. However, on the employee’s return to a domestic assignment, CGFS will evaluate the employee’s state tax withholding election based on his or her new ocial domestic duty station. Rental of Home Taxpayers who rented out their homes in 2014 can continue to deduct mort- gage interest as a rental expense. Also deductible are property management fees, condo fees, deprecia- tion costs, taxes and all other rental expenses. Losses up to $25,000 may be o- set against other income, as long as the Modified Adjusted Gross Income does not exceed $100,000 to $150,000 and the taxpayer is actively managing the property. Note that a taxpayer who retains a property manager does not lose this benefit, as this is still considered active management of the property. All passive losses that cannot be deducted currently are carried forward and deducted in the year the property is sold. Sale of a Pr incipal Residence Current tax laws allow an exclusion of up to $500,000 for couples filing jointly and up to $250,000 for single taxpayers on the long-term gain from the sale of their principal residence. One need not purchase another resi- dence to claim this exclusion. All depreciation taken after May 7, 1997, will, however, be recaptured (added to income) at the time of sale and taxed at 25 percent. Since January 2009, gain from the sale of a home can no longer be excluded from gross income for periods when it was rented out before you occupied it as a principal residence for the first time. The only qualification for the capital-gains exclusion is that the house sold must have been owned and occupied by the taxpayer as his or her principal residence for at least two of the last five years prior to the date of the sale. Mi l i tary Fami l ies Tax Rel ief Act As a result of the Military Families Tax Relief Act of 2003, the five-year period may be extended for mem- bers of the Foreign Service by any period during which the taxpayer has been away from the area on a Foreign Service assignment, up to a maximum of 15 years (including the five years). There are some exceptions to the two-year occupancy requirement, including a sale due to a “change in place of employment” (this would include foreign transfers). This exclusion is not limited to a once-in-a-lifetime sale, but may be taken once every two years. When a principal resi- dence is sold, capital gains realized above the exclusion amounts are subject to taxa- tion. This exclusion replaces the earlier tax-law provision that allowed both the deferral of gain and a one-time exclu- sion of a principal residence sale. Temporary rental of the home does not disqualify one from claiming the exclu- sion. The 2003 law requires only that you have occupied the house as your principal residence for the required period (two years out of five, extended). However, new legislation in 2009 requires that the “two years out of five (extended)” cannot start until the date the home is occu- pied as a principal residence for the first time. Under Internal Revenue Code Section 1031, taxpay- ers whose U.S. home may no longer qualify for the principal residence exclusion may be eligible to replace the property through a “tax-free exchange” (the so-called Starker Exchange). In essence, one property being rented out may be exchanged for another, as long as that one is also 2014 AFSA TAX GUIDE