The Foreign Service Journal - January/February 2018

78 JANUARY-FEBRUARY 2018 | THE FOREIGN SERVICE JOURNAL AFSA NEWS (discussed below). However, the property may become eli- gible for an IRC Section 1031 exchange. This tax provision is normally invoked by businesses exchanging like-kind, income- producing property. The IRS rules for these exchanges are complex and specific, with a number of pitfalls that can nullify the transaction. A 1031 exchange should never be attempted without assistance from a tax or real estate professional spe- cializing in this field. (4) Selling a Principal Residence: (4)(a) A taxpayer may exclude up to $250,000 ($500,000 if married filing jointly) of long-term capital gain from the sale of a principal residence. To qualify for the full exclusion amount, the taxpayer: (i) must have owned the home and lived there for at least two of the last five years before the date of the sale (but see Military Families Relief Act below); (ii) cannot have acquired the home in a 1031 exchange within the five years before the date of the sale; and (iii) cannot have claimed this exclusion during the two years before the date of the sale. An exclusion of gain for a fraction of these upper limits may be possible if one or more of the above requirements are not met. A taxpayer who sells their principal residence for a profit of more than $250,000 ($500,000 for married filing jointly), or a reduced amount, will owe capital gains tax on the excess. (4)(b) Military Families Tax Relief Act of 2003: The five-year period described above may be suspended for members of the Foreign Service by any 10-year period dur- ing which the taxpayer has been away from the area on a Foreign Service assignment, up to a maximum of 15 total years. Failure to meet all of the requirements for this tax benefit (points (i) through (iii) in the Selling a Principal Resi- dence section above) does not necessarily disqualify the taxpayer from claiming the exclusion. However, the services of a tax professional will probably be necessary if one of these requirements is not met. (4)(c) Adjustments to the Basis of a Home: (i) Buying or Building a Home: Some investments in the construction of a home, purchase of a home, improvements during ownership and improvements in preparation to sell must be added to the basis of the home. The starting point is the amount paid to acquire the property: cost basis. Some settlement fees and closing costs may be added to the cost basis (yielding the adjusted basis). These include abstracts of title fees, charges for installing utility services, legal fees for the title search and preparing the sales contract and deed, recording fees, survey fees, transfer or stamp taxes and title insurance. A taxpayer who builds a home may add the cost of the land and the cost to complete the house to arrive at an initial cost basis. Construction includes the cost of labor and materials, amounts paid to a contractor, archi- tect’s fees, building permit charges, utility meter charges and legal fees directly connected with building the house. (ii) Improving a Home During Ownership: During the ownership period, improvements to the home including additions (bedrooms, bathrooms, decks), lawn and grounds improvements (landscaping, paving a driveway), improve- ments to the exterior (storm windows, new roof, siding), insulation, plumbing, interior improvements (built-in appli- ances, kitchen modifications, flooring) and investments in the home systems (heating, central air, furnace) may all be added to adjust the basis of the home upward. (iii) Preparing to Sell: “Fixing-up costs” no longer exist insofar as they refer to what was once recognized as a 1034 exchange of a residence. Capital expenditures continue to operate as described above when a taxpayer is preparing to sell a home. Any capital improvements when preparing to sell should simply be added to the adjusted basis and sub- tracted from the sales price to reduce net capital gain when the home is sold. (iv) Selling: Selling expenses can be subtracted from the sales price, further reducing the taxable gain. These include fees for sales commissions, any service that helped the tax- payer sell the home without a broker, advertising, legal help, and mortgage points or other loan charges the seller pays that would normally have been the buyer’s responsibility. IMPORTANT NOTE: FOREIGN EARNED INCOME The Foreign Earned Income Exclusion may permit U.S. citizens who are not U.S. government employees and who pass the previously discussed FEIE tests to exclude up to $102,100 of their 2017 foreign-source income if they meet certain requirements. Taxpayers must add the amount excluded under the FEIE back to their AGI to figure what their tax liability would be, then exclude the tax that would have been due on the exclud- able income alone to properly calculate their tax liability with an FEIE exclusion. For example: A Foreign Service employee earns $80,000 and their teacher spouse earns $30,000. Tax liability on $110,000 gross income is $18,978; tax on $30,000 foreign income is $3,568; and net tax liability is $18,978 minus $3,568, or $15,410.