The Foreign Service Journal, February 2003

FEBRUARY 2003 • AFSA NEWS 7 MCG FINANCIAL PLANNING Former State Department Employee Stationed Overseas Understands Unique Financial Situation of Foreign Service Services Include: Retirement Planning Tax Preparation and Strategies Analysis: Insurance and Investments Lump SumRetirement Options MARY CORNELIA GINN 4630 Montgomery Avenue, Suite 220 Bethesda, Maryland 20814 Phone: (301) 951-9160 Fax: (703) 938-2278 E-mail: mcgfin@erols.com S ECURITIES OFFERED THROUGH N ATHAN & L EWIS S ECURITIES , I NC ., M EMBER NASD& SIPC. MCG F INANCIAL P LANNING AND N ATHAN & L EWIS ARE NOT AFFILIATED ENTITIES . coulddefer all or part of the gain if youpur- chased or built another home (of equal or higher value) within two years before or after the sale. The current tax laws allow an exclu- sion of up to $500,000 for couples filing jointly and up to $250,000 for single tax- payers on the gain from the sale of their principal residence. All depreciation taken afterMay 7, 1997, will, however, be recap- tured (added to income) at the time of sale, and taxed at 25 percent. The only qualification for the capital- gains exclusion is that the house soldmust have been the taxpayer’s principal resi- dence and owned by the taxpayer for at least two of the last five years prior to the date of the sale. There are some exceptions to this two-year requirement including sales connected to a change in place of employment (this would include foreign transfers). This exclusion is not limited to a once-in-a-lifetime sale, butmay be taken once every two years. When a principal residence is sold, capital gains realized above the exclusion amounts are subject to taxation. This exclusion replaces the earlier tax-lawpro- vision that allowed both the deferral of gain and a one-time exclusion of a prin- cipal residence sale. Many Foreign Service employees are hurt by the “two-out-of-five-years” res- idency requirement. AFSA, working closely with the military, has repeatedly tried to persuade Congress to pass legis- lation granting an exemption for Foreign Service personnel who cannot meet this requirement due to prolonged overseas service, and came very close in 2002. However, these efforts have not yet been successful. Temporary rental of the home does not necessarily disqualify one fromclaim- ing the exclusion. The new tax law requires only that you have occupied the house as your principal residence for the required period (two years out of five). Under Internal Revenue Code Section 1031, taxpayers whose U.S. homemay no longer qualify for the principal residence exclusion may be eligible to replace the property througha“tax-free exchange” (the so-calledStarker exchange). Inessence, one property being rented out may be exchanged for another, as long as that one is also rented. In exchanging the proper- ties, capital gains tax may be deferred. Technically, a simultaneous tradeof invest- mentsoccurs.Actually, owners first sell their property, place the equity proceeds in escrow, identify in writing within 45 days theproperty they intend toacquire, andset- tle on the new property within 180 days, using the money held in escrow as part of the payment. It is important to emphasize that the exchange is fromone investment proper- ty toanother investment property– the key factor in the IRS evaluationof an exchange transaction is the intent of the investor at the time the exchangewas consummated. The IRS rules for the exchanges are com- plex and specific, with a number of pitfalls that can nullify the transaction. An exchange shouldnever be attemptedwith- out assistance from a tax lawyer specializ- ing in this field. ad to come