THE TAX PROPHET: Frequently Asked Questions:  December  2002

Q:  A residence is gifted to you. After you have lived in the residence for about 1 year you decide to sell it. Do you owe Capital gains?

A:  Yes. You owe capital gains on the sale. To become eligible for the $250,000 exclusion, you must own and live in the home for at least 24 of the 50 months prior to a sale. Under your facts, you owned the residence for just 12 months prior to sale. In general, capital gains is the difference between the amount you realized from the sale and the basis of the donor (your basis carries over from the donor), plus any improvements you've made to the property.

For instance, if the donor purchases a residence for $100,000, makes no improvements and gifts you the residence when it is worth $500,000, your basis is $100,000. If you meet the residence exclusion requirements (see the next question for details) and then sell it for $500,000, you will be entitled to exclude $250,000 of your $400,000 gain (the exclusion is $500,000 if you are married and file a joint return).

Q:  I understand the 1997 law that allows an exclusion of $500,000 in profits from the sale of a residence for married couples. My home was purchased for $50,000 (20 years ago) and is now worth $900,000. Providing that the ownership and use tests have been met is it not possible to purchase a second residence using the equity in the first residence without tax?

A:  No. There is an exclusion for the first $500,000 of profit, provided you qualify under the residence exclusion rules (generally, you must own and live your residence for at least 24 of the 50-month period prior to sale). There is no longer the right to rollover the gain from one residence to another of equal or greater value on a tax-free basis. Remember, your basis in your residence is not just the purchase price, but includes any improvements made to the residence (less depreciation taken if any).

Consider converting a portion of the residence to investment property (if possible) then using a combination of the residence exclusion and the tax-free exchange rules under IRC Sec. 1031 in one transaction - to eliminate tax on the gain from the disposition of your residence.

Q:  The owner of a foreign company producing in Mexico and China wants to hire me. Does it matter if I'm a U.S. taxpayer working in the U.S.?

A:  Yes. The issue is whether the foreign company would be engaged in a trade or business in the U.S. and whether it has a fixed place of business. These are difficult and sometimes complex factual determinations, but those are the issues. If you are working in the U.S., then there is a tax issue. If you are working exclusively outside the U.S. and are not using another company in the U.S. as your agent (a complicated concept that requires analysis), then the company is probably not engaged in a trade or business in the U.S.

To the extent the person is physically present in the U.S., or is using a U.S. agent to sell goods, the company is engaged in a trade or business in the U.S., regardless of the residence of the taxpayer engaging in activities on behalf of the company.

If the taxpayer is not physically present in the U.S. and from a foreign location engages in sales activities exclusively by telephone or mail with customers physically present in the U.S., then the company is not engaged in a trade or business in the U.S. Whether or not you are a U.S. resident is not relevant - whether you (or another person on behalf of the company) are physically present in the U.S. selling goods (personally or through an agent) is the relevant inquiry. In short, it is not your residency status, but the location of your activities that govern the issue.

Q:  I want to open a U.S. dollar bank account in the United States and I am not a . resident or citizen. What are the tax consequences?

A:  You can deposit funds in a bank account in the U.S. and not pay tax on the interest. Also, your funds are not subject to U.S. estate taxes. Just contact a bank, explain that you are a foreign person, and complete the paperwork (usually, Form W-8BEN). If you become a U.S. resident or citizen, you'll pay tax on the bank interest. The initial deposit of funds is never taxable under our income laws, although for a U.S. taxpayer, bank deposits are part of the gross estate for federal estate-tax purposes.

All contents copyright © 1995-2002 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.