Caps on Costs in Homesale Programs Should Be Avoided
Mobility magazine, November 2016
Companies that offer homesale benefits to employees sometimes ask whether there is a way to control the costs that may be incurred by imposing limits on those costs, referred to here as “caps.” Because the company is buying and then selling the employee’s old home, and must do so in a way that will satisfy Internal Revenue Service requirements that the two sales be separate and independent—see Rev. Rul. 2005-74, explained below—costs may be significant. But meeting those requirements is important because it means that the homesale costs will not be taxable to the employee and will not need to be grossed up.
In an appraised value, amended value (AV), or buyer value option (BVO) program, the employee does not realize any income from avoiding the costs of selling the home to an ultimate purchaser because that sale is regarded as separate and independent from the sale to the employer or relocation management company. The costs incurred are considered costs of the employer, not costs of the employee reimbursed by the employer.
Consequently, the costs do not have to be withheld upon, no employment taxes are due, nor is any gross-up required. If that second sale is not separate and independent, however, the employee will be regarded as the seller, and all costs will be taxable to the employee as wages.
A cap on homesale program expenses is a way of reducing the cost exposure to the company and shifts the burden of a part of the cost of the homesale program to the employee. Although the answer is not absolutely clear, there is a substantial risk that such program provisions would cause the IRS and the courts to conclude that the two sales are not separate and independent, and that the real seller in the ultimate sale to the outside buyer is the employee, not the company. A program cost cap that shifts homesale risk to the employee, no matter how structured, therefore, will expose the home purchase program to significant risk that all the costs will be taxable to the employee. Consequently, such program provisions should be avoided.
How is a cost cap imposed? There are a number of possibilities. For example, a company might limit the broker commission it will pay to 5 percent. Or, it might impose either a percentage or overall cost cap on all real estate sale expenses. Such a program might, for example, limit the total of all real estate sale costs to 7 percent of the homesale price, or limit those costs to $10,000. Another approach to the issue is to provide a lump sum from which real estate sale costs must be paid.
Program cost caps tend to be particularly attractive to companies moving from a direct reimbursement program to a homesale program. Such caps are appealing because many companies with direct reimbursement programs already include some type of reimbursable cost cap, or real estate cost lump sum, in their program, and they are reluctant to eliminate those controls and to take on the full cost of the homesale. There is no tax issue with this approach in a direct reimbursement program because all amounts actually given to the employee or incurred on the employee’s behalf are taxable wages, no matter how they are computed. It is only when the company wants to avoid that tax result by using a homesale program that the caps become an issue.
Homesale program expense caps shift the burden and risk of a part of the cost of a homesale to the employee. As noted, in a direct reimbursement program, there is nothing wrong with that from a tax perspective. Once the company decides to institute a homesale program, however, the picture changes, and the shifting of risk to the employee is a problem.
In 1985, Worldwide ERC® published a list of 11 key elements of an AV transaction. These were developed by Worldwide ERC®’s Public Policy Committee (now Tax Forum) and are intended to provide the best case to support the independence of the two sales. They also apply to the BVO. The principles contained in the 11 key elements were followed by the IRS in Rev. Rul. 2005-74, 2005-2 C.B. 1153, in holding that appraised value and standard amended value transactions result in two separate, independent sales in which costs are not taxable to employees. A key to this conclusion is full assumption of ownership risk by the company. But capping the costs the company will absorb results in a significant diminution of those ownership risks. The company is limiting its exposure to the full costs of homeownership.
A company whose program contains caps still has ownership risk. If the second sale falls through, for example, the company will be responsible for the costs of carrying the property, and it still must bear its share of the disposal costs. But the fact remains that it has left part of the ownership responsibility with the employee in the form of part of the disposal costs. From a tax perspective, that may well be enough to cause the program to fail.
Rev. Rul. 2005-74 explicitly relies for its conclusion on the employer or relocation management company bearing all the burdens of ownership and, as noted, is modeled after—although it does not cite—the 11 key elements. Consequently, any provision in a program that is inconsistent with full assumption of ownership risk or that links the employee to the second sale is highly inadvisable. A cap that shifts homesale cost risk to the employee, no matter how it is structured, will expose the home purchase program to significant tax risk.
Peter Scott is Worldwide ERC® tax counsel and principal of Peter K. Scott Associates. He can be reached at +1 910 579 5332 or [email protected].
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