The Foreign Service Journal, January 2003

year ownership or use tests can still qualify for a reduced exclusion if they sold their home 1) due to a change in place of employment, or 2) for health reasons. The exclusion is reduced proportionally according to the amount of time the taxpayer lived in the residence sold; for example, a tax- payer who lived in the house for only one year would be entitled to exclude a maximum of $125,000 in gain, as opposed to $250,000 if he or she had met the two-year test. A couple filing jointly can combine their individual exclusions, based on how long each person lived in the house. For example, if one member of the couple had lived only four months in the house during the five years preceding its sale, and the other had lived one year and nine months, they could exclude the reduced maxi- mum of $250,000 in gain. The own- ership test also reduces the maximum potential exclusion proportionately. And even if one member of the cou- ple filing jointly owned the property for a shorter period than the other spouse, both spouses are treated as owning the property for the longer period. Worksheet 3 of Pub. 523 shows how to calculate both kinds of proportional reductions in the maxi- mum allowed exclusion. Although Pub. 523 lists “unfore- seen circumstances” as a third accept- able means by which to qualify for a reduced exclusion, the IRS has not yet issued a regulation defining that term. Until it does so, no one can claim a reduced exclusion under that provision. There is increasing press speculation that the IRS is preparing to issue a regulation defining “unfore- seen circumstances.” Foreign Service personnel assigned to Washington who are retir- ing can take advantage of the reduced maximum exclusion by accepting post-retirement employment outside the Washington, D.C., area. The tax- payer is not required to purchase another property at the new place of employment, or to change employers. To claim the reduced exclusion for health-related reasons, the taxpayer should be prepared to provide evi- dence of a specific health problem or need that required the sale of the res- idence. Other Options A Foreign Service employee can also claim the reduced exclusion even if, during the two-year period ending on the date of sale, he or she had already sold another home at a gain and excluded all or part of that gain. Ordinarily, a taxpayer would be barred from claiming any exclusion under those circumstances. However, if the second sale is due to a change in place of employment or for health reasons, the taxpayer can take a reduced exclusion. Another means to obtain a full exclusion works best for packrats who never throw out their records or receipts. Taxpayers who postponed all or part of the gain on the sale of a previous home when they bought the home on which they now seek to exclude gain are entitled to count the time living in and owning the previous home toward the two-year use and ownership tests, respectively. To pre- sent the strongest possible case if questioned (and the stakes may well be high enough to encourage the IRS to challenge such a claim), the taxpay- er should be able to produce the tax return with the Form 2119 on which the postponed gain was reported. The taxpayer should also be prepared to substantiate his residence in the previous home for the period of time that he wishes to count toward the use and ownership tests. (Old utility receipts, if available, are a strong proof of residence.) An unmarried taxpayer who has both the Form 2119 and proof of residence could qualify for the $250,000 exclusion while a married couple filing jointly with such backup could qualify for the full $500,000 exclusion. For example: You sold a home you lived in for nine months in 1985, rolled the gain into a new residence in 1986 and reported postponing that gain (by rolling it over into the new residence) to the IRS on a Form 2119 attached to your 1986 return. You were posted overseas in 1995 and did J A N U A R Y 2 0 0 3 / F O R E I G N S E R V I C E J O U R N A L 19 F S F I N A N C E S AFSA Will Keep Trying A FSA Director of Congressional Relations Ken Nakamura reported Nov. 22 that the sought-after legislation failed to pass on a technicality and thus will have to be taken up in the 108th Congress next year. His Legislative Update e-mail provided the follow- ing synopsis of what the exclusion provision would have done for Foreign Service members: “The capital gains tax exclusion provision, which affects both the uniformed and Foreign Service, would have: • allowed a person to be away from the property for up to five additional years (tolled years) as part of the “look back” criteria. Thus, within a 10-year period, the homeown- er would have had to occupy the property for two years. • the tax exclusion would have been retroactive to 1997, and would have been treat- ed as if it had been part of the original law when enacted. • to qualify for the tax exclusion, the homeowner would have to be on official orders with the duty station more than 150 miles away from the residence. • the allowable five-year tolling of years could be used more than once. Thus, if a person used the exclusion and tolled the full five years, and bought another house, the five-year tolling would be allowable the next time the homeowner wanted to sell the new house that was bought.” — Edward J. Michal