The Foreign Service Journal, February 2005

FEBRUARY 2005 • AFSA NEWS 3 expenses claimed for family members. If a hotel bill indicates double rates, the sin- gle roomrate shouldbeclaimed, and, ifpos- sible, the hotel’s rate sheet should be saved for IRS scrutiny. Car rental, mileage and otherunreimbursedtravel expenses, includ- ing parking fees and tolls, may be deduct- ed. The rate forbusinessmilesdriven is37.5 cents formiles driven during 2004. Those whouse thisoptionalmileagemethodneed not keep detailed records of actual vehicle expenses. However, they should keep a detailedodometer log to justify thebusiness use of the vehicle and track the percentage of business use. This optional mileage method applies to leased vehicles as well. Official Residence Expenses Since Oct. 1, 1990, employees who receive official residence expenses (ORE) have not been allowed to reduce their reportable incomeby fivepercent. The IRS ruling regarding ORE states that “usual expenses,”definedas 5percent of salary, are not deductible. Therefore the only expen- ses that are deductible are those above the 5 percent paid out of pocket. Employees should save receipts for any out-of-pocket expenses associated with their representa- tionalduties. Theseexpenses canbededuct- ed as miscellaneous business expenses. Home Ownership Individuals may deduct interest on up to $1 million of acquisition debt for loans securedbya first and/or secondhome. This also includes loans taken out for major home improvements. On home equity loans, interest is deductible on up to $100,000, nomatter howmuch the home cost, unless the loan is used for home improvements. The $100,000 ceiling applies to the total of all home equity loans youmayhave. The same generally applies to refinancing a mortgage. Points paid to obtain a refinanced loan cannot be fully deducted the same year, but must be deductedover the lifeof the loan. It is advis- able to save the settlement sheet (HUD-1 Form) fordocumentation in the event your tax return is selected by the IRS for audit. Qualified residences are defined as the taxpayer’sprincipal residence andoneother residence. The second home can be a house, condo, co-op,mobilehome, orboat, as long as the structure includes basic liv- ing accommodations, including sleeping, bathroomand cooking facilities. If the sec- ond home is a vacation property that you rent out for fewer than 15 days during the year, the income need not be reported. Rental expenses cannot be claimed either, but all property taxes andmortgage inter- est may be deducted. Rental of Home Taxpayers who are overseas and rented their homes in 2004 can continue to deductmortgageinterestasarentalexpense. Also deductible are property management fees,condofees,depreciationcosts,taxesand all other rental expenses. Losses up to $25,000maybeoffset againstother income, as longas theAGIdoesnot exceed$100,000 and the taxpayer is actively managing the property. Retainingapropertymanagerdoes not mean losing this benefit. Sale of a Principal Residence The current capital-gains exclusion on the sale of a principal residence on or after May 7, 1997, applies to all homeowners regardless of their age. Previously, quali- fied individuals who were age 55 or older wereallowedaone-time capital-gains exclu- sionof $125,000. Also, underprevious law, if youhadagainwhenyousoldyourhome, youcoulddefer all or part of the gain if you purchasedor built another home (of equal or higher value)within two years before or after the sale. The current tax laws allowan exclusion of up to $500,000 for couples filing joint- ly and up to $250,000 for single taxpayers on the gain from the sale of their princi- pal residence. One need not purchase another residence to claim this exclusion. All depreciation taken after May 7, 1997, will, however, be recaptured (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 havebeen the taxpayer’s principal residence and owned by the taxpayer for at least two of the last five years prior to the date of the sale. As stated above, the five-year period may be extended based on any period in which the taxpayer has been outside the U.S. on Foreign Service assignment, to a maximum of 15 years (including the five years). There are some exceptions to the two-year requirement, including a sale for the “change in place of employment” rea- son (this would include foreign transfers). This exclusion is not limited to a once-in- a-lifetime sale, butmaybe takenonce 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. Temporary rental of thehomedoes not disqualifyone fromclaiming the exclusion. Thenewtax lawrequiresonly that youhave occupied the house as your principal res- idence for the required period (two years out of five, extended). Under Internal Revenue Code Section 1031, taxpayers whoseU.S. homemay no longer qualify for the principal residence exclusion may be eligible to replace the property througha“tax-free exchange” (the so-called Starker exchange). In essence, one property being rented out may be JOSH