IRS ruling on relocation home sale programs

Late in 2005, the IRS published Revenue Ruling 2005-74, which is the first formal expression of an IRS position on the taxability of costs in relocation home sale programs since Rev. Rul. 72-339 was issued in 1972. All companies with home sale programs should consider whether the ruling has an effect on their current procedures. The following is a brief explanation of the ruling and how it might impact common practices and procedures.
Appraised Value and Amended Value Programs
The ruling provides, for the first time, an unqualified IRS endorsement of these basic programs, including a description of the procedures followed that conforms to the standards that have been in use in the industry for many years. The amended value transaction approved by the IRS is one conforming to the “eleven key elements” that have been the basic standard for such programs since 1985. Companies who have been utilizing these procedures now have comfort that their program will not be challenged by the IRS. Companies whose program falls short of the standard procedures described by the IRS should consider whether any of the nonconforming procedures should be changed. A fuller discussion of those procedures that are questionable under the ruling is included in the section “changes to consider” below.

Blank Deed
Rev. Rul. 2005-74 says unequivocally that a bona fide sale from the transferee to the relocation management company occurs whether or not a blank deed is utilized. Therefore, for federal tax purposes it is not necessary to use a “two-deed” process. In this regard, the ruling represents a repudiation of the Tax Court’s Amdahl opinion, in which use of the blank deed was one of the factors cited in determining that the employer never became the owner of the houses. The ERC recommendation in 2001 to use two deeds, which was based primarily on the IRS audit position after Amdahl, is no longer applicable for federal tax purposes. Companies using two deeds should consider returning to a blank deed process in many states.
Altair cautions, however, that there may still be states in which use of two deeds should be considered. Altair understands that ERC will provide further information on this issue in the near future.

Buyer Value Option Programs
The new ruling does not address the Buyer Value Option (BVO) program. However, the procedures that the IRS has approved for an Amended Value (AV) program are, once the employee begins marketing and receives an offer, exactly the same as those used in a BVO. In a properly structured BVO program, the only difference from an Amended Value program is that there is no initial appraisal and guaranteed offer. The “eleven key elements” are equally applicable to both programs. It is not certain how IRS field agents will view BVOs after the ruling, but companies will have a very strong position, based on the ruling, that their BVO program is merely a type of AV, and that non-taxability of the costs is fully supported by the ruling, provided the same procedures are being followed.
Like companies with AV programs, companies using BVO programs should examine the procedures being used, compare them to those approved in the ruling, and consider whether to change any that do not conform. Companies who have not already done so should also consider adding a “delayed Amended Value” feature to their BVO program. The principal weakness in a BVO program, and the principal difference from an AV as described in the ruling, is the lack of a guaranteed buyout. Consequently, companies should consider structuring their BVO program as a “delayed Amended Value,” in which appraisals are done and a guaranteed offer is made at some point after the employee has marketed the house without success.

Changes to Consider
Rev. Rul. 2005-74, in addition to approving standard appraised value and amended value programs, includes a description of a third program that the IRS will challenge. The differences in that program from the approved AV are essentially three: (1) the offer to the employee at the higher, outside price is contingent on the relocation management company contracting at that price with the outside buyer; (2) the employee retains the right to negotiate changes in the relocation management company’s contract with the outside buyer; and (3) the proceeds representing the higher amended value are paid to the employee only if and when the outside sale closes.
The exact meaning of the language used by the IRS is not clear, nor is it clear how the IRS will interpret it in practice. However, Altair believes that companies with AV or BVO programs should reexamine practices under which a contract is not entered into with the employee until a contract is in place with the outside buyer, inspections have been completed, and any adjustments have been negotiated with the buyer and the employee. The IRS may well conclude that such practices place the program in the unfavorable fact pattern in the ruling and contend that costs are taxable to employees. This is particularly true if payment of full equity is delayed until after the outside sale closes. Furthermore, companies might consider changing procedures in which the employee is involved in negotiations with the buyer after the relocation management company has a contract in place with the buyer. Examination of these issues may lead to consideration of performing inspections earlier in the process.

Deduction Issue
Since 1982, the IRS has contended that deductions for most of the costs incurred in a home sale program are capital, deductible only against capital gains. See Rev. Rul. 82-204. Altair, like ERC and most others in the relocation industry, has always believed that the IRS is wrong, and that companies have a strong argument for an ordinary loss deduction.
The new ruling is silent on this issue, but the IRS has not abandoned the issue and is expected to argue that, if the company followed the approved procedures in Rev. Rul. 2005-74, costs (other than carrying costs like maintenance, mortgage interest and taxes, and fees to the relocation management company) are deductible only as a capital loss. However, as noted, there are strong arguments to the contrary.
The new ruling assumes a cost-plus pricing method. Two separate, independent sales must occur or the costs will be taxable to employees, and the employer will owe employment taxes on those costs. Companies considering use of a fixed fee pricing method should be careful that the procedures used by the relocation management company are within those approved by the IRS in the new ruling.

Summary
Altair believes that the new ruling will be of great assistance when helping companies determine how to structure their home sale programs to achieve tax certainty, and will eliminate in many cases the costs incurred through the use of two deeds. The ruling also highlights some practices that the IRS considers questionable, and which companies may wish to reconsider. Companies may also wish to bring the ruling to the attention of their own tax department or outside tax advisors.