The Foreign Service Journal, January-February 2020

THE FOREIGN SERVICE JOURNAL | JANUARY-FEBRUARY 2020 71 the taxpayer: (1) must have owned the home and lived there for at least two of the last five years, beginning on the date first occupied, before the date of the sale (but see Military Families Relief Act, below); (2) cannot have acquired the home in a 1031 exchange within the five years before the date of the sale; and (3) 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. Taxpayers who sell their principal residence for a profit of more than $250,000 ($500,000 for married filing jointly) will owe capital gains tax on the excess. AFSA recommends Topic 701, Publication 523, IRC Sec. 121 and related regulations. Military Families Tax Relief Act of 2003 According to the Military Families Tax Relief Act of 2003, the five-year period described above, beginning on the date you first occupy your residence, may be suspended for members of the Foreign Service for any 10-year period during 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 (1) through (3) in the Selling a Principal Residence sec¬tion above) does not necessarily disqualify the taxpayer from claiming the exclusion. However, the services of a tax profes¬sional will probably be necessary if one of these requirements is not met. In addition to the recommended reading from the previous section, AFSA recommends review- ing IRC Sec. 121(d)(9) and 26 CFR Sec. 1.121-5. Business Use of Home Although most Foreign Service families find themselves in government-funded housing overseas much of the time, some may own property in the United States that they both occupy for personal purposes and use to operate a private business on the side. To qualify for a deduction for business-related expenses for a portion of a residence used for a business, a taxpayer must use a portion of their home exclusively and regularly as a principal place of business (and file a Schedule C), as a rental property or for a daycare facility. A taxpayer who meets that threshold must then either calculate the actual expenses of the home office—e.g., cost of a business phone line and part of state and local property taxes, utilities, mortgage interest and depreciation—or use the IRS’ simplified method based on a flat rate for the square foot- age used for business (up to a maximum of 300 square feet). Also note that expenses incurred for the entire home, such as property taxes, must be prorated based on the percentage of the home used exclusively for the business if you choose the regular (not simplified) calculation. For more information, contact a professional and read IRS Topic 509, Publication 587, the instructions for Form 8829, 1040 Schedule C, and IRC Sections 162, 212 and associated regulations. Depreciating Real Property Used to Produce Income The cost of income-producing capital property, such as resi- dential and nonresidential rental property, is deductible over the IRS-defined recovery period for the structure or property. The deductible portion of income-producing property is referred to as depreciation. To calculate annual depreciation, a taxpayer must know the property’s cost basis, adjustments to basis (tracked throughout the life of the property), the date the property was placed in service as income-producing property, and the IRS-required depreciation method and convention. The IRS requires a taxpayer to depreciate buildings, certain land improvements and other types of capital assets—all annually. The IRS prohibits a taxpayer, however, from depre- ciating land, including the land on which a depreciable asset sits, such as a residential rental property. So land values must be accounted for separately. Property used for personal pur- poses may not be depreciated and claimed for tax purposes. Taxpayers who believe they have sufficiently documented their property to begin using it for income-producing pur- poses should contact a tax professional to properly set up a business, calculate business expenses (including deprecia- tion), account for income derived from the property and file correct tax forms on time each year. AFSA recommends also reading Tax Topics 703 (basis), 704 (depreciation) and 414 (rental property); the Schedule E and 1040 instructions; IRC Sections 167 (depreciation), 1012 (cost basis), 1011 (adjusted basis) and 1016 (adjustments to basis); associated basis and depreciation regulations; and Publications 527 and 946. Professional assistance may be necessary for a possible IRC Section 1031 Exchange of like-kind, real property located in the United States, which is held for the production of income (i.e., not a personal residence, but possibly domestic rental property). Charitable Contributions Up to 60 percent of a taxpayer’s income base can be deducted for charitable contributions. Common issues include contributing to a qualified organization, properly documenting contributions of $250 or more, accounting for benefits received in return for donations and calculating the income base. Note that the Tax Cuts and Jobs Act of 2017 significantly restricts deductions for contributions to colleges and universities in return for the right to buy tickets to sport- ing events. Refer also to the new IRS regulations linking this