Many companies have questions about what to
do with an employee's home when he or she is moved to a new job location,
especially when the real estate market is in a downturn throughout much of the
country.
Typically, the employer wants to protect the
employee against financial loss on a "forced" sale of the home.
Outlined below are some of the most common ways to do that, and the
consequences to the employee.
The employer reimburses the employee's financial loss. Here the employer has
the home appraised and agrees to pay the employee the difference between the
appraised fair market value and any lesser amount the employee gets on the
sale. Such reimbursement would cover the employee's costs of the sale.
Note: The financial loss here is not the same as a tax loss.
The financial loss is the home's value less what the employee collects under
"forced sale" conditions. In the current real estate market, the
value is not always clearly determined. The relocating employee might think the
home is worth more, based on earlier appraisals or comparative sales. A tax
loss is the property's tax basis (cost plus capital investments) less what's
collected on the sale.
If the employee has a gain on the sale (the
amount collected on the sale exceeds the basis), gain can be tax-exempt up to
$250,000 ($500,000 on certain husband-wife sales). However, tax loss on the
sale of one's residence is not deductible.
The employer's reimbursement of the
employee's financial loss is considered taxable pay to the employee. Employers
who want to shelter the employee from any tax burden on what is usually an
employer-instigated relocation may "gross-up" the reimbursement to
cover the tax. But gross-up can be costly. For example, a grossed-up income tax
reimbursement for a $10,000 loss would be $15,385 for an employee in the 35%
bracket - more where Social Security taxes or state taxes are also grossed-up.
Employer buys the home. Few employers directly buy and sell employees' homes.
But many do this indirectly, effectively becoming the homes' owners, through
use of relocation firms acting as the employers' agents. An IRS ruling shows
how to do this with no tax on the employee:
Option 1. The relocation firm as employer's agent buys the home
for its appraised fair market value, and later resells it. The firm collects a
fee from the employer, which covers sales costs and any financial loss to the
firm on resale. The IRS now says that this fee is not taxable to the employee.
Also, the employee's gain on the sale to the relocation firm qualifies for the
tax exemption under the limits described above ($250,000 or $500,000).
Option 2. The relocation firm offers to buy the home for its
appraised value, but the employee can choose to pursue a higher price through a
broker he or she chooses from a list provided by the relocation firm. If a
higher offer is made, the relocation firm pays that price to the employee
(whether or not the home is then sold to that bidder). Here again, the employee
is not taxed on the firm's fee and the gain is tax exempt under the above
limits.
Tip: Either option works for the employee, letting him or her
realize full value on the sale of the home (with possibly greater value through
Option 2), without an element of taxable pay.
Caution: If the deal is structured so that the relocation firm
facilitates a sale from the employee to a third-party buyer (rather than to the
relocation firm), the employer's payment of the relocation firm's fee is
taxable to the employee.
The Employer's Side
Reimbursing the employee's loss. This is fully deductible as a business expense, as would
be any additional amount paid as a gross-up.
Note: It's fully deductible, but it may be more costly, before
and after taxes, than buying the home for resale through the relocation firm.
Note: Paying the relocation fee only, without buying the home,
as in the "Caution" above, is also fully deductible, as would be any
gross-up amount on that fee.
Buying the home. The change in the IRS rule was good news for employees,
but it gave nothing to employers, whose tax treatment wasn't covered. The
official IRS position is that employer costs (other than carrying costs such as
mortgage interest, maintenance, and fees to a relocation management company)
are deductible only as capital losses, which, for corporate employers, are
deductible only against capital gains. Taxpayer advocates tend to argue that employer
costs here are fully deductible ordinary costs of doing business.
Questions?
Are you an employee who is being relocated
this fall? Are you wondering about the sale of your home and the tax
implications for you? We can answer your questions. Just give us a call.
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