The Foreign Service Journal, May 2003

W ith little fanfare, the IRS delivered a stocking stuffer for homeowners on Christmas Eve 2002 that could be worth tens of thousands of dollars to Foreign Service personnel. While Congress continues to consider — with strong encouragement from AFSA, among many others — the conferral of a specific, permanent exclusion from the capital gains tax on home sales for Foreign Service and military personnel, the Treasury Department has issued temporary regulations that greatly broaden the circumstances under which home- owners who sell their residences can claim a reduced maximum capital gains exclusion (see the January 2003 FSJ FS Finances article, “Claiming the Tax Exclusion for Gain on Home Sales”). Specifically, the regulations offer a series of “safe harbors” — situa- tions that automatically confer eligi- bility for the reduced maximum exclusion. These offer valuable relief to Foreign Service personnel who have suffered the indignity of holding onto a no-longer-needed primary residence to avoid paying capital gains tax or, worse, who already paid that tax on the sale of such a home in 2000 or later. And, sweetening the pot even further, the IRS will allow home- owners who sold their residence before Dec. 24, 2002 (the effective date of the regulations), either to file a return for 2002 that does not include the gain that otherwise would have been taxed, or to file an amended return to obtain a refund of tax paid on sales prior to 2002. The new regulations are tempo- rary and potentially subject to revi- sion because the IRS received so many suggestions for circumstances that could trigger eligibility for the reduced maximum capital gains exclusion that it needs extra time to tweak the proposed provisions. So the clock is ticking: April 15, 2003, was the last day to claim a refund for capital gains tax paid on a 1999 sale, and April 15, 2004, will be the deadline to claim a refund for capital gains tax paid on a 2000 sale (assuming no further changes to the regulations). Make no mistake, though: tempo- rary though they may be, these reg- ulations have an extraordinary potential to liberate Foreign Service personnel from the tyranny of the two-year residency test for the home sale capital gains exclusion. That test requires persons contemplating sale of their primary residence to have lived there at least two out of the five years immediately preceding the date of the sale to qualify for the full $500,000 exclusion of gain, if married filing jointly, or the full $250,000 exclusion, if filing under other statutes. Safe Harbors Under the previous set of regula- tions, persons not meeting the two- year test could qualify for a reduced maximum exclusion (figured propor- tionately according to the number of days of occupancy of the property divided by 730; i.e., two years) if they were selling the property due to reasons arising out of a change in employment, health, or “unforeseen circumstances.” However, the IRS had not defined “unforeseen cir- cumstances” and therefore would not allow exclusions based on that factor. The new regulations define that term and thereby greatly expand the ability of persons who do not meet the two-year test to reduce or even eliminate home sale capital gains tax. The easiest way to qualify for the reduced exclusion under the new regulations is for your circumstances to fit within one of the “safe harbors” — events that automatically qualify a taxpayer for a reduced exclusion — described therein. The IRS has developed specific “safe harbors” for 20 F O R E I G N S E R V I C E J O U R N A L / M A Y 2 0 0 3 A Retroactive Windfall for Home Sellers B Y E DWARD J. M ICHAL FS F INANCES AFSA continues to lobby Congress to grant a specific, permanent exclusion from the 2-in-5-year rule for FS personnel selling their homes.