Tax consequences of home purchase programs for relocating employees.

Each year, thousands of employees--current and newly hired--relocate to new job sites annually. For homeowners, there are expenses connected with selling one's home and buying another. To induce employees to relocate and facilitate their transition, employers offer various bundles of benefits; home purchase programs are often among the services provided.

Background

Under a home purchase program, an employer relocating an employee arranges to purchase the latter's home at a certain price; alternatively, the employer may contract with a third-party relocation company to administer a buyout on its behalf. The IRS treats transactions involving a relocation company as conducted by the employer via an agency relationship.

Typically, the buyout results in a two-transaction sale--a sale of the residence by the employee to the employer, followed by a sale from the employer to a third-party buyer. After the first sale, the employer may incur expenses for maintenance, utilities, insurance, property taxes, broker's commission, closing costs, mortgage payments (if the employee is paid only the equity in the home and the employer assumed the mortgage) and other expenses directly attributable to a specific residence. However, the employer may recoup all or part of its expenses through proceeds from the subsequent sale to the third-party buyer.

The tax consequences of home purchase programs vary, depending on the program's structure. Rev. Rul. 2005-74, case law and previous IRS guidance collectively provide insight on the tax effects of such programs.

Rev. Rul. 2005-74

The ruling's underlying purpose is to provide guidelines to determine whether an employer acquired ownership of a residence as the property is ultimately transferred from an employee to a third-party buyer during the course of the home purchase program. Once identified as an owner, the appropriate tax treatment may be assigned to a seller-employer, as well as a seller-employee, on the property's disposition.

Overview: According to the ruling, a sale of the home occurs on a transfer of the benefits and burdens of ownership. While satisfaction of the technical requirements for passage of legal title under state law does not necessarily determine ownership, the ability to realize a profit or loss from the sale of property is consistent with ownership. If the benefits and burdens are transferred from the employee to the employer at any point during the program's administration, the employee is deemed to have sold the residence to the employer, followed by a second sale of the property from the employer to a third-party buyer. If the benefits and burdens of ownership are not so transferred, the employee is deemed to have sold the residence to a third-party buyer with the employer's assistance.

Facts and analysis: Although the specifics may vary from company to company, Rev. Rul. 2005-74 sets forth three scenarios that might typically represent the structure of a home purchase program administered by a relocation service provider as an employer's agent.

In the first scenario, the employee effectively sells the residence to the employer via the relocation company. The buyout price is typically the average of two or three appraisals. Although the property is transferred to the relocation company, it does not insert its name as grantee on the deed, nor record the deed. Subsequently, the employer sells the property to a third-party buyer. The relocation company inserts the ultimate buyer's name on the deed as grantee, and then records the deed.

The second scenario is the same, except the buyout price may be determined by an "amended value option," which provides an employee (1) with a buyout price equal to the appraised value as a floor and (2) the ability to sell the house to the employer at a higher price. Under this option, the employee can list the house with a real estate broker to locate a prospective buyer who will offer more than the appraised value. If such an offer is received, the employer--acting through its agent--amends the original offer and purchases the home at the higher bid price. On the subsequent sale by the employer, the property may or may not be sold to that prospective buyer. Further, the employee is not entitled to any part of any gain realized if the price received by the employer on the sale of the home to the third-party buyer exceeds the amount paid to the employee for the home. The relocation company inserts the ultimate buyer's name on the deed as grantee, and then records the deed.

Applying a benefits-and-burdens analysis in the above scenarios, the ruling concludes that each overall transaction resulted in two separate sales; thus, the tax consequences to the seller-employee and seller-employer must be analyzed. As discussed below, the seller-employee may have taxable gain on the disposition of the residence, but does not have taxable compensation income for the employer's costs. The ruling does not address the tax consequences to the employer on the acquisition and subsequent sale of the property.

The third scenario is the same as the second, but with a variation in the terms and conditions of the amended value option. The employee's sale of the home to the employer at the higher amended price is contingent on the employer, acting through the relocation company, entering into a contract with the actual prospective buyer located by the employee. In addition, the employee retains the right to negotiate the sale of the residence to such buyer. Further, the proceeds representing the higher amended value are distributed to the employee, provided the sale of the home to the third-party buyer closes. The ruling concludes that the employee retains beneficial ownership; thus, the IRS treats the overall transaction as one sale of the residence from the employee to the third-party buyer, facilitated by the employer. The third-party buyer is listed on the deed. Consequently, the employee may have taxable gain on the property's disposition, as well as taxable compensation income for any expenses incurred by the employer.

Tax Consequences

Rev. Rul. 2005-74 discusses the tax consequences of the three scenarios. Generally, if the overall transaction is treated as two separate sales (as in the first two scenarios), the employee must account for realized gain on the sale of the residence to the employer, unless it is excluded from gross income under the Sec. 121 principal residence exclusion ($250,000 for single taxpayers; $500,000 for married taxpayers filing jointly); see Secs. 1001 and 61(a)(3). For Federal tax purposes, however, no part of the employer's expenses gives rise to compensation income to the employee, even though local law or custom treats the costs as obligations of the seller-employee.

On the other hand, if the transactions are treated as one sale (as in the third scenario), the employee's gain on a disposition will be taxed in the same manner, but the employer's expenses will be treated as compensation income to the employee; see Secs. 61(a)(1) and 82.

Open question: If the employee is treated as having compensation income, the ruling does not address the employer's payroll tax obligation. Under Sec. 82, however, employer-paid moving expenses included in an employee's gross income are compensation for services. Such "wages" are excepted from Federal payroll tax if it is reasonable to believe that a corresponding deduction is allowable to the employee under Sec. 217; see Rev. Rul. 70-482.

Dispositions

The ruling also does not discuss the employer's income tax consequences on the property's disposition. If the employer is deemed to acquire ownership of the residence (i.e., two-transaction sale treatment), the property may be characterized either as a capital or an ordinary income asset. Such characterization dictates the tax consequences to the employer on the subsequent sale of the residence to a third-party buyer.

Capital asset: If the residence is characterized as a capital asset in the employer's possession, a subsequent sale by the employer for a profit will result in capital gain. Corporate employers do not benefit from the tax advantages of capital gains (i.e., preferential tax rates), because such amounts are taxed at the same rate as ordinary income; see Secs. 11 and 1201. However, they do inherit the disadvantages of capital assets if a loss is sustained on disposition. Particularly, a capital loss may be deducted only to the extent of capital gains, with a three-year carryback and five-year carryforward; see Sec. 1211(a) and (b). Unlike corporate employers, noncorporate employers may use the capital loss to offset capital gains and up to $3,000 of ordinary income, and may carry over capital losses indefinitely; see Secs. 121 l(b) and 1212(b).

Ordinary income asset: If the residence purchased by the employer is characterized as an ordinary income asset, and the employer subsequently sells the residence for a profit, ordinary income results and is taxed at the same rate as a capital gain. If the subsequent sale results in a loss, an ordinary deduction arises; see Sec. 162 or 165.

Because gain on the conversion of a capital or ordinary income asset produces the same tax result, corporate employers may be indifferent as to characterization. If the sale of the property generates a tax loss, however, ordinary deduction treatment may be preferable.

Acquisitions

Rev. Rul. 2005-74 is also silent on the characteristics of a home purchase program associated with the acquisition of a capital asset or ordinary income asset by the employer. In Rev. Rul. 82-204, however, the IRS sets forth circumstances that might result in capital asset characterization, including the employer's intentions, frequency of transactions and holding periods of properties.

In Azar Nut Co., 94 TC 455, aff'd, 931 F2d 314 (5th Cir. 1991), the IRS prevailed in asserting capital asset characterization. In a one-time-only transaction, a corporate taxpayer purchased the residence of a former executive-employee. Under a stipulation in the employment contract that accommodated an executive who sold his home and relocated to the new job site, the employer was required to purchase the executive's new home in the event of termination. The courts held the employer's loss on the sale of the property to be a capital loss.

However, in Amdahl Corp., 108 TC 507 (1997), the IRS was unsuccessful in its assertion that the residences involved in the home purchase program were capital assets in the employer's hands, causing ordinary deductions for the related expenses to be unavailable. The Tax Court determined that the employer did not acquire beneficial ownership of the residences. Any expenses it bore conferred taxable benefits to the relocating employees, in which ordinary deductions were available under Sec. 162(a). In Amdahl, the relocating employees continued to retain the benefits and burdens of ownership of the residences, because they held legal title pending sales to third-party buyers and received any profits from the sales.

Conclusion

With the tax consequences of the employee and employer intertwined, an employer that maintains home purchase programs for its relocating employees should be aware of the tax outcomes for both parties.

FROM CARLISLE F. TOPPIN, J.D., LL.M., WASHINGTON, DC