AFSA NEWS 52 JANUARY-FEBRUARY 2024 | THE FOREIGN SERVICE JOURNAL Selling a Principal Residence—IRC Section 121 Taxpayers who sell real estate used as a principal residence at some time during the taxpayer’s ownership may qualify to exclude all or a portion of their net taxable capital gain under the provisions of IRC Section 121. A taxpayer who used the property as a principal residence and also rented out the property at any time during ownership can only exclude the qualifying IRC Section 121 capital gain, which is the capital gain other than the gain created under IRC Section 1250 (see below for a discussion of IRC Section 1250). IRC Section 121 allows an exclusion of qualifying capital gain up to $500,000 MFJ or $250,000 for all other filing statuses. To qualify for the full IRC Section 121 exclusion, the taxpayer(s): (1) must have owned the home and lived there as their principal residence at any time for at least two of the last five years 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 MFJ) will owe capital gains tax on the excess. Additionally, capital gain attributed to periods of nonqualified use cannot be excluded under IRC Section 121. 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 (which AFSA was instrumental in enacting), the five-year period to qualify for the exclusion under IRC Section 121 may be suspended for members of the Foreign Service for up to 10 years during which the taxpayer has been on a qualifying Foreign Service assignment. This act also excludes periods of “qualified official extended duty” from nonqualified use treatment. In addition to the recommended reading from the previous section, AFSA recommends IRC Sec. 121(d)(9) and 26 CFR Sec. 1.121-5. Selling a Property That Was Previously Rented—IRC Section 1250 Taxpayers who sell a property that was used as a rental property at any time during the taxpayer’s ownership must reduce the property’s adjusted basis by the mandatory depreciation required during the rental period of the property (even if the taxpayer did not properly claim depreciation deductions) before calculating the final net taxable capital gain from the property sale. The portion of the net capital gain created from the mandatory depreciation (whether or not claimed during the rental period[s]) is taxed as IRC Section 1250 unrecaptured gain and is not eligible for capital gain exclusion under IRC Section 121. The portion of the remaining net capital gain is eligible for exclusion under IRC Section 121 if all requirements are met. Due to the impact of IRC Section 1250 unrecaptured gain rules, taxpayers who sell a property that was previously rented often still have a tax bill due even if they qualify to exclude a portion of their net capital gain under IRC Section 121. AFSA recommends Topic 701, Publication 523, IRC Sec. 1250, and related regulations. Non-Rental 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 to report the business activity). A taxpayer who meets that threshold must then either calculate the actual expenses of the home office—e.g., cost of a business phone/internet line and the business use portion 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 footage used for business (up to a maximum of 300 square feet). For more information, contact a professional and follow up with IRS Topic 509, Publication 587, the instructions for Form 8829, 1040 Schedule C, and IRC Sections 162, 212, and associated regulations. Three Separate but Related Child and Dependent Credits Child Tax Credit. A qualifying child for purposes of 2023 tax returns is one who has not attained age 17 by Dec. 31, 2023. The child tax credit is up to $2,000 for each qualifying child. The qualifying income thresholds to claim the maximum child tax credit are as follows: modified adjusted gross income up to $400,000 if MFJ, or up to $200,000 for all other filing statuses for the maximum $2,000 per qualifying child. The child tax credit is fully refundable up to $1,600 per child. Other Dependent Credit. A separate but related Other Dependent Credit of up to $500 is available, often for those who do not meet the qualifying child requirement or for other dependent relatives. Calculate both the child tax credit and the other dependent credit on the Child Tax Credit and Credit for Other Dependents Worksheet. The worksheet and a flow chart for determining “Who Qualifies as Your Dependent?” are in the Form 1040 instructions. AFSA also recommends Publi-
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