Many companies are asking “What to do about an employee’s home when he or she is moved to a new job location? This is an increasing tough and costly question with the real estate market tightening throughout much of the country.
Typically, the employer wants to protect the employee against financial loss on a “forced” sale of the home. Here are the most common ways to do that, and their consequences to the employee:
Employer reimburses employee’s financial loss
Here the employer has the home appraised and agrees to pay employee the difference between that appraised fair market value and any lesser amount the employee gets on sale. Such reimbursement would cover the employee’s costs of 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. Relocating employee might think the home is worth more based on an earlier appraisals or market sales. A tax loss is the property’s tax basis (cost plus capital investments) less what’s collected on sale.
If the employee has a gain on the sale (amount collected on sale exceeds basis), gain can be tax-exempt up to $250,000 ($500,000 on certain husband-wife sales). Tax loss on sale of one’s residence is not deductible.
The employer’s reimbursement of the employee’s financial loss is 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 $14,575 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. A 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 will cover sales costs and any financial loss to the firm on resale. IRS now says that this fee is not taxable to the employee. Also, the employee’s gain on sale to the relocation firm qualifies for the tax exemption under the limits ($250,000 etc.) described above.
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 gain is tax exempt under the above limits.
Tip: Either option works for the employee, letting him or her realize full value on 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 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: Fully deductible, but maybe 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 WARNING 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 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.
Tip: Where employee relocation is in prospect—and that can include relocating new hires—employee and employer need to consult their professional advisers for the wisest financial and tax course.