The Foreign Service Journal, January-February 2022

THE FOREIGN SERVICE JOURNAL | JANUARY-FEBRUARY 2022 59 the transaction(s) on their income tax return. Taxpayers who receive virtual currency as payment for services must report currency received as income on their tax return. Virtual cur- rency that a taxpayer holds as an investment is generally taxed as a capital gain or loss, as described in the preceding section. AFSA recommends consulting IRS Notice 2014-21, Revenue Ruling 2019-24 and the FAQs to determine the tax treatment, if any, of a transaction. Investments in Real Estate Taxpayers generally invest in real estate in four scenarios: Scenario 1: To live in as their personal residence. Scenario 2: For use as a vacation home. Scenario 3: To live in as their personal residence, but may rent it out at times when not living in it. Scenario 4: To rent to a third party strictly for investment income purposes with no personal use. Adjusted Basis In all four scenarios, it is important to properly calculate the adjusted basis of the property. Please refer to Tax Topic 703; Publication 551; Form 1040 Schedule D with instructions; IRC Sections 1011, 1012 and 1014 through 1017; and associated tax regulations beginning at 26 CFR Sec. 1.1012-1. Recent itera- tions of the annual tax seminar offered by the Foreign Service Institute have illustrated how mistakes in tracking basis can result in incorrectly calculated depreciation of rental proper- ties and incorrectly reported gain or loss from the sale of real estate. Please contact the FSI Transition Center for a link to view the most recent seminar, which discusses the permitted approaches to correct mistakes in basis. Scenario 1: Personal Residence Never Rented. While living in the property as a personal residence, a taxpayer may deduct mortgage interest and property taxes as an itemized deduction on Schedule A, subject to limitations. Note that current tax law allows a taxpayer to deduct mortgage interest up to current mortgage limits ($375,000 MFS/$750,000 MFJ unless the mortgage meets the requirements for grandfa- thered mortgage limit of $500,000 MFS/$1 million MFJ) for up to two properties, a personal residence and a second home personally used by the taxpayer. Interest paid on home equity loans (including popular HELOCs) is no longer deductible unless the proceeds from the loan are used to substantially improve the property on which the HELOC is taken, and the total mortgage loan balance (including home equity loans) stays within the permitted mortgage limits. Scenario 2: Vacation Home. A vacation home is a home that may be used by you and is rented out at times during the year. If you use the vacation home without renting it out, you may deduct the mortgage interest and property taxes on Schedule A, subject to limits as described in Scenario 1. If you rent out your vacation home for fewer than 15 days during the year, you are not required to report the rental income on your tax return and you may still deduct the mortgage interest and taxes on Schedule A. If you rent the vacation home out more than 14 days, but use it personally for the greater of 14 days or 10 percent of the number of days rented, it is considered a personal residence and you may not deduct rental expenses greater than rental income. Mortgage interest and real estate taxes allocated to personal use are reported on Schedule A, subject to limitations. Mortgage interest, real estate taxes and other deductible expenses (including depreciation) allocated to rental use are reported on Schedule E using the vacation home rules. Scenarios 3 and 4: Rental Property. Real estate that you purchase as a personal use home and then convert to rental status (or vice versa) or real estate that you purchase for imme- diate rental to a third party both have similar requirements for calculating depreciation during the rental period and for capital gain or loss calculations upon sale. During periods when the property is rented, the taxpayer must report the gross rental income received and deductible expenses paid on Schedule E. Please review the annual Foreign Service Institute Tax Seminar presented each February (please contact the FSI Transition Cen- ter for a link to view the most recent seminar) for complications to consider when deciding which expenses are immediately deductible and which expenses must be capitalized and depre- ciated during rental use. Depreciating Rental Property Used to Produce Income During periods when real estate is rented, the IRS requires the taxpayer to depreciate the property over the IRS-defined recov- ery period. To calculate annual depreciation, a taxpayer must know: (1) the property’s adjusted cost basis and fair market value at time of rental conversion (the taxpayer must use the lower of the fair market value or adjusted basis as the deprecia- ble basis); (2) adjustments to basis (tracked throughout the life of the property); (3) the date the property was placed in service as income-producing; and (4) the IRS-mandated depreciation method and convention. The IRS requires a taxpayer to depre- ciate buildings, certain land improvements and other types of capital assets—all annually. The IRS, however, prohibits a taxpayer from depreciating land, including the land upon which a depreciable asset sits. So, land values must be accounted for separately. Property used for personal purposes 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 purposes should contact a tax professional to properly set up the prop-