Author: Leon Clinton

Here’s good news. IRS regulations allow you to claim a prorated (reduced) gain exclusion—a percentage of the $250,000 or $500,000 exclusion in select circumstances.

The prorated gain exclusion equals the full $250,000 or $500,000 figure (whichever would otherwise apply) multiplied by a fraction. 

The numerator is the shorter of 

• the aggregate period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or 
• the period between the last sale for which you claimed an exclusion and the sale date for the home currently being sold. 

The denominator is two years, or the equivalent in months or days.  

When you qualify for the prorated exclusion, it might be big enough to shelter the entire gain from making a premature sale. But the prorated exclusion loophole is available only when your premature sale is due primarily to

• a change in place of employment, 
• health reasons, or 
• specified unforeseen circumstances.

Example. You’re a married joint-filer. You’ve owned and used a home as your principal residence for 11 months. Assuming you qualify under one of the conditions listed above, your prorated joint gain exclusion is $229,167 ($500,000 × 11/24). Hopefully that will be enough to avoid any federal income tax hit from the sale.

Premature Sale Due to Employment Change 

Per IRS regulations, you’re eligible for the prorated gain exclusion privilege whenever a premature home sale is primarily due to a change in place of employment for any qualified individual.

“Qualified individual” means

1. the taxpayer (that would be you), 
2. the taxpayer’s spouse, 
3. any co-owner of the home, or 
4. any person whose principal residence is within the taxpayer’s household.

In addition, almost any close relative of a person listed above also counts as a qualified individual. And any descendent of the taxpayer’s grandparent (such as a first cousin) also counts as a qualified individual.  

A premature sale is automatically considered to be primarily due to a change in place of employment if any qualified individual passes the following distance test: the distance between the new place of employment/self-employment and the former residence (the property that is being sold) is at least 50 miles more than the distance between the former place of employment/self-employment and the former residence.

Premature Sale Due to Health Reasons

Per IRS regulations, you are also eligible for the prorated gain exclusion privilege whenever a premature sale is primarily due to health reasons. You pass this test if your move is to 

• obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or 
• obtain or provide medical or personal care for a qualified individual who suffers from a disease, an illness, or an injury. 

A premature sale is automatically considered to be primarily for health reasons whenever a doctor recommends a change of residence for reasons of a qualified individual’s health (meaning to obtain, provide, or facilitate care, as explained above). If you fail the automatic qualification, your facts and circumstances must indicate that the premature sale was primarily for reasons of a qualified individual’s health. 

You cannot claim a prorated gain exclusion for a premature sale that is merely beneficial to the general health or well-being of a qualified individual. 

Premature Sale Due to Other Unforeseen Circumstances

Per IRS regulations, a premature sale is generally considered to be due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that you could not have reasonably anticipated before purchasing and occupying the residence. 

But a premature sale that is primarily due to a preference for a difference residence or an improvement in financial circumstances will not be considered due to unforeseen circumstances, unless the safe-harbor rule applies. 

Under the safe-harbor rule, a premature sale is deemed to be due to unforeseen circumstances if any of the following events occur during your ownership and use of the property as your principal residence:

• Involuntary conversion of the residence 
• A natural or man-made disaster or acts of war or terrorism resulting in a casualty to the residence
• Death of a qualified individual
• A qualified individual’s cessation of employment, making him or her eligible for unemployment compensation
• A qualified individual’s change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household
• A qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance
• Multiple births resulting from a single pregnancy of a qualified individual

If you are looking at a need for the prorated home-sale gain exclusion and would like my help, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 29, 2021

In what clearly must be a mistake, the IRS issued Notice 2021-49 to deny the employee retention credit (ERC) on the wages paid to most C and S corporation owners.

According to the IRS:

• Your corporation can qualify for the ERC on the wages paid to a more than 50 percent owner of an S or C corporation if that owner does not have any living brothers and sisters (whether whole- or half-blood), spouse, ancestors, or lineal descendants.
• Your corporation cannot qualify for the ERC on the more than 50 percent owner’s wages if one of those relatives (other than the spouse) is alive.

Example 1. Tom owns 100 percent of his S corporation, and he has no living relatives. Under this new IRS notice, Tom’s corporation can qualify for up to $33,000 in ERC on Tom’s wages.

Example 2. John owns 100 percent of his S corporation, but he has one living relative, a two-year-old daughter. John’s corporation does not qualify for the ERC. Under the new IRS notice, the two-year-old daughter owns by attribution 100 percent of the S corporation, and the IRS says that John, now a tainted relative, works for her and does not qualify for the ERC.

Whoa, that’s not logical!

Also, it may be technically incorrect.

And it’s possible that lawmakers will kill this IRS rule.

To Amend or Not to Amend

Let’s start with this premise. You are a more than 50 percent owner of a corporation. You thought that your corporation qualified for the ERC. At various times before August 4, 2021, the day when the IRS issued Notice 2021-49, you filed your claim to the ERC for 2020 and the first two quarters of 2021.

As we mentioned, when you filed, you believed (as a more than 50 percent owner of a C or S corporation) that wages paid to you by the corporation qualified for the ERC. We did too.

But then, on August 4, 2021, the IRS issued Notice 2021-49 and said no—you don’t qualify. What now? Here’s what we think you should do:

1. Wait. Do nothing now. There’s no hurry. You have until April 15, 2024, before you have to do anything about your 2020 ERC.
2. Wait. Don’t claim the ERC for the more than 50 percent corporate owner for calendar year 2021 quarters 3 and 4 until you have clarification that you qualify. Again, there’s no hurry. You can file a Form 941-X anytime within the three-year statute of limitations.

If you are upset by this IRS notice, it’s a good idea to communicate that dissatisfaction to your U.S. senators and congressional representatives. For some ideas on what message to convey, here’s a sample letter for your use.

And if you would like to discuss this ERC development, don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 25, 2021

If you buy a property, fix it up, and then sell it, is that property a dealer or an investor property?

Here are five thoughts on this:

1. Periodically buying property, fixing it up, and selling it makes it look like dealer property. But when you seldom do this, the property can look like investor property.
2. If you hold the property for more than a year from the time of purchase to the close of escrow, investor status gives you tax-favored, long-term capital gains treatment.
3. When you buy and sell without fixing up the property, or when you buy and rent and then sell, you have strong investor attributes.
4. The fix-up, remodel, development, etc., give you dealer attributes.
5. The whole issue of dealer versus investor status is a facts-and-circumstances classification, and it’s a tough call.

If you are planning on buying investment property and have tax questions, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 22, 2021