The Foreign Service Journal, January-February 2016

72 JANUARY-FEBRUARY 2016 | THE FOREIGN SERVICE JOURNAL 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 occupied 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 rental prop- erty may be exchanged for another, as long as that one is also rented. In exchanging the proper- ties, capital gains tax may be deferred. Technically, a simul- taneous trade of investments occurs. Actually, owners first sign a contract with an inter- mediary to sell their property, hold the cash proceeds in escrow, identify in writing within 45 days the property they intend to acquire, and settle on the new property within 180 days, using the money held in escrow as part of the payment. It is important to empha- size that the exchange is from one investment property to another investment prop- erty—the key factor in the IRS evaluation of an exchange transaction is the intent of the investor at the time the exchange was consum- mated. The IRS rules for these exchanges are complex and specific, with a number of pit- falls that can nullify the trans- action. An exchange should never be attempted without assistance from a tax lawyer specializing in this field. Ca l c u l a t i ng You r Ad j u s t ed Ba s i s Many Foreign Service employees ask what items can be added to the cost basis of their homes when they are ready to sell. Money spent on fixing up the home for sale may be added to the basis. To qualify as legitimate fixing-up costs, the follow- ing conditions must be met: (1) the expenses must be for work performed during the 90-day period ending on the day on which the contract to sell the old residence was signed; (2) the expenses must be paid on or before the 30th day after sale of the house; and (3) the expenses must not be capital expenditures for permanent improvements or replacements (these can be added to the basis of the property, the original pur- chase price, thereby reducing the amount of profit). A new roof and kitchen counters are not “fix-up” items, but paint- ing the house, cleaning up the garden and making minor repairs qualify. The Af fo rdab l e Ca r e Ac t The Affordable Care Act imposed two new tax increases beginning in 2013. There is a 3.8-percent net investment tax on net invest- ment income to the extent it is in excess of MAGI of $250,000 for those married filing jointly, and $200,000 for those filing single. Net investment income includes interest, dividends, rents, royalties, pensions and annui- ties, and gain from the sale of property. Secondly, the rate of the Medicare tax that is withheld from employees’ paychecks is increased by 0.9 percent on salaries or self-employment earnings over the same thresholds. n TAX WITHHOLDING WHEN ASSIGNED DOMESTICALLY In 2014, the State Department instituted new procedures to comply with Treasury regula- tions for withholding state taxes for all employees serving domestically. (See Department Notice 2014_11_016, dated Nov. 3, 2014.) This means state taxes will be withheld for an employee’s “regular place of duty”—in other words, your official duty station. If you require state taxes to be withheld for a state other than that of your official duty station, your bureau executive director must provide a certification to the department’s Bureau of the Comptroller and Global Financial Services. This does not mean that you must relinquish your state of domicile if it is different than your official duty station. “Domicile” (legal residence) is different from“residence,” and so long as you maintain your ties to your home state you will be able to change your with- holdings, 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 does 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, upon the employee’s return to a domestic assignment, CGFS will evaluate the employee’s state tax withholding election based on his or her new official domestic duty station.