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THE FOREIGN SERVICE JOURNAL

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JANUARY-FEBRUARY 2017

65

the burden of “usual” household expenses of 3.5 percent of their

salary (see 3 FAM 3253.1). None of the 3.5 percent of “usual”

household expenses is deductible because it is “payment for

ordinary, everyday living expenses, and is not excludable from

gross income” (see Revenue Ruling 90-64). These expenses

cannot be deducted as miscellaneous business expenses

because they are personal expenses. Official expenses for which

any State Department employee is not reimbursed are deduct-

ible as unreimbursed employee expenses.

Home Owne r s h i p :

Home ownership may trigger many tax benefits including: (1)

The mortgage interest deduction; (2) Deduction of points to

obtain a home mortgage; (3) Business use of a home; and (4)

Selling a home.

(1) Mortgage Interest Deduction:

The interest expense of

up to $1 million of acquisition debt ($500,000 for individual

filers) and up to $100,000 home equity debt ($50,000 individu-

ally) for loans secured by a primary or secondary residence

may qualify for a deduction. The properties for which a taxpayer

would like to take this deduction must qualify as a home or a

secondary residence.“Home” is the place where a taxpayer ordi-

narily lives most of the time. A secondary residence is a property

the taxpayer does not rent out (or attempt to sell) during the

year. Note that the structure claimed as a home or secondary

residence may be a house, condominium, cooperative, mobile

home, house trailer, boat or similar property that has sleeping,

cooking and toilet facilities.

(

2) Points on a Mortgage:

Taxpayers who claim the above

deduction may also qualify to currently deduct all the points

paid to obtain that mortgage. Nine requirements must be met

to deduct those points. Taxpayers should contact a tax profes-

sional to see if they qualify and explore the possibility of partially

deducting these points. Save the settlement sheet (HUD-1

Form) for documentation in case of an audit.

(3) Business Use of Home, Including as a Rental:

Taxpay-

ers may be entitled to deductions for the business use of part of

a home.

(3)(a) Rental:

When income is earned by renting out the

home, deductions the taxpayer claims for mortgage interest

remain deductible; however, they become an expense for the

production of rental income instead of a personal deduction

under the mortgage interest expense provisions (Schedule E

rather than Schedule A). Depreciation, repair costs and operat-

ing expenses such as fees charged by independent contractors

(e.g., groundskeepers, accountants, attorneys) are deductible.

Limits apply to these deductions when the taxpayer uses their

property for the greater of 14 days or 10 percent of the total

days it is rented to others at a fair rental price.

(3)(b) The 1031 Exchange:

Taxpayers who convert their

homes to investment property (perhaps because they have

inadvertently used it exclusively for business purposes for too

long) may no longer qualify for the exclusion of up to $500,000

of capital gain on the sale of a principal residence (discussed

below). However, the property may become eligible for an IRC

Section 1031 exchange. This tax provision is normally invoked by

businesses exchanging like-kind, income-producing property.

The IRS rules for these exchanges are complex and specific,

with a number of pitfalls that can nullify the transaction. A 1031

exchange should never be attempted without assistance from a

tax professional specializing in this field.

(4) Selling a Principal Residence:

(4)(a)

A taxpayer may exclude up to $250,000 ($500,000

for married filing jointly) of long-term capital gain from the sale

of a principal residence. To qualify for the full exclusion amount,

the taxpayer: (i) must have owned the home and lived there for

at least two of the last five years before the date of the sale (but

CHILD CARE TAX CREDIT WHEN OVERSEAS

Bear in mind that in order to claim the child care tax credit

while serving overseas, you must submit IRS Form 2441, for

which the instructions say: “For U.S. citizens and resident

aliens living abroad, your care provider may not have, and

may not be required to get, a U.S. taxpayer identification

number (for example, an SSN or EIN). If so, enter “LAFCP”

(Living Abroad Foreign Care Provider) in the space for the

care provider’s taxpayer identification number.”

IMPORTANT NOTE:

FOREIGN EARNED INCOME

The Foreign Earned Income Exclusion allows U.S. citizens

who are not United States government employees and are

living outside the United States to exclude up to $101,300

of their 2016 foreign-source income if they meet certain

requirements. Since 2006, you have been required to take

your total income and figure what your tax would be, then

deduct the tax that you would have paid on the excludable

income.

For example: A Foreign Service employee earns $80,000

and their teacher spouse earns $30,000.

Before 2006

: Tax on $110,000 minus $30,000 = tax on

$80,000 = tax bill of $13,121.

Since 2006

: Tax on $110,000 = $20,615; tax on $30,000

= $3,749; total tax = $20,615 minus $3,749 = tax bill of

$16,866.