An intro to tax problem & discussion!

I was hired four years ago in 2003 by the NE Corp. to serve as the CEO for their company. I relocated from Chicago to Boston to accept the position. As part of my employment contract, if they fired me, then they agreed to purchase my residence at FMV. Last year, in 2006 NE Corp, unsatisfied with my performance, fired me, and purchased my residence for $625,000.00. I purchased the house for $500,000.00 back in 2003. NE Corp immediately listed the house with a real estate agency. But soon after the purchase, the real estate market in the area experienced a serious decline, especially in higher priced homes. NE Corp sold the house in 2006 for

500,000.00 and paid selling expenses of $22,000.00. My questions are: a. What are my tax consequences? (i.e., how much is the gain/loss that is realized and /or recognized on the sale of my residence; and does any portion of the transaction qualify as compensation?) b. What are the tax consequences to the company, NE Corp? (i.e., how much is the gain or loss realized and or recognized on the sale of the residence; and does this qualify as an ordinary and necessary business expense or is it a capital loss?
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Reply to
tax akademik
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Your consequences: Assuming that you made no improvements to that house and you had no buying or selling expenses you have a long term capital gain of $125,000 but since this was your principal residence for two of the last 5 years your gain is exempt from taxation. You will still need to do a Schedule D Companies consequences: They can take a loss of $125000 + $22000. They will probably do it as a write down.

Reply to
Avrum Lapin

"tax akademik" wrote

I wouldn't look at it as compensation, because you didn't have to do anything for them to be obligated to buy your house, and income or profit wasn't guaranteed. The sale of the house seems to qualify for the gain exclusion under Section121.

I'm sure they'll find a way to deduct it all.

It seems it would be a cost of doing business, and not a capital transaction.

-- Paul A. Thomas, CPA Athens, Georgia

Reply to
Paul Thomas, CPA

My first thought is that it would be compensation, but for the taxpayer's sake I hope I'm wrong. There is no guarantee of income or profit from nonstatutory stock options either

-- what's the difference? At the very least, I would expect some difficulty in showing that the purchase was truly at FMV. Normally that requires parties with adverse interests in an arm's-length transaction. The $22,000 of selling expenses that the company paid seems to me like a form of taxable reimbursement. Somehow this sounds too good to be true -- a tax-free transfer of money from employer to employee under terms of an employment contract.

-Mark Bole

Reply to
Mark Bole

While I encourage my students to read this news group I make it clear that an answer to assignment based solely on posts here is insufficient for a passing grade. I hope your instructor has told you and your fellow students the same.

Reply to
Bill Brown

(snipped)

As to the house:

Interesting take on the issue, Paul. To my way of thinking, it seems to be an asset they would have "purchased", and therefore a schedule d item. Could go either way of course. I wonder.....

ChEAr$, Harlan Lunsford, EA n LA

Reply to
Harlan Lunsford

There's no guarantee of profit from sale of the house at FMV, either.

Why? Presumably the company got an appraisal in order to determine FMV prior to purchasing the house. Why do you think it might invent an arbitrarily high "FMV" in order to give more money to a _fired_ employee?

The company and the ex-employee have adverse interests: the purchase price is a 0-sum game.

Again, since the market weakened a lot between the company's purchase and sale, perhaps the selling expenses the ex-employee would have seen would have been a lot lower.

If the market had risen between the company's purchase and sale, the company would have made money, with the "transfer" being in the opposite direction. Seth

Reply to
Seth

[...]

For the same reason companies give fired executives golden parachutes -- to induce them to go quietly, for the sake of future business relationships, and so on. My point was this seems like some kind of tax-free golden parachute payment. We're using the term "fired" here loosely -- if he was truly fired for cause (theft, gross violation of company policy, etc) then in I think all employment agreements are off. If he was "let go", that's a different matter. Even rank-and-file employees who are laid off are often unilaterally offered severance payments if they sign off to not sue the company. Those payments are taxable compensation.

But it certainly wasn't an arm's-length transaction, due to the employment contract, and in fact even their interests were not necessarily adverse, since the relationship between company and CEO encompassed much more than just this real estate transaction.

Certainly it was common knowledge in 2006 that residential real estate had peaked in late 2005 and that local "bubbles" were in the process of deflating, if not bursting. A true FMV transaction would have taken this knowledge into account. That begs the question -- why would the company bother committing to such a thing in the first place? A commitment to buy an asset at FMV has an economic value of zero, since by definition you can always sell an asset at FMV without any prior commitment from anyone. Of course the company helped the employee avoid the transaction costs, which again seems to me like a taxable reimbursement. I'm just wondering, in an audit situation, would the tax-free nature of this transaction between an employer and employee be questioned? As previously noted in another reply, this seems more like a contrived class exercise than a real-life situation.

-Mark Bole

Reply to
Mark Bole

The original employment contract was an arms-length transaction. So when the employer purchased the fired employee's home for fair market value, it was a legitimate price. The fact that the property later sold for less doesn't prove that the purchase price from the employee was too high. But if they did pay more than the actual value at that time, the balance would be taxable as salary.

It's actually a common provision in contracts where the employee is required to relocate. If it doesn't work out, he doesn't want to have to have the hastle of hanging around until the place sells - he just wants to move back where he can from. There's nothing wrong with that. As far as avoiding transaction costs, lots of people do that by selling their own homes. Should they be taxed on the amount they saved when they do that?

I'd guess that an auditor might well look into whether the sale was for fair market value. The IRS often challenges values put on things by taxpayers. Stu

Reply to
Stuart Bronstein

(I'm only responding because I consider this a "tax akademik" learning opportunity and not a real-life situation). That's the first I've heard of the transitive property of arm's-length transactions. For example, since my mortgage contract was entered into as an arm's-length transaction, does that mean that if the bank calls in my loan early and I must sell my house by the end of the month to avoid foreclosure, that the sale is therefore also an arm's-length transaction? But more to the point, I'm still hung up on the taxable differences between an employment contract and a real estate sales contract.

Which appears to be a concern of the OP from the beginning....

Why does relocation need to be involved? If it is this simple and easy, why don't Silicon Valley firms routinely offer their execs a clause that says, "if we decide to end your employment early, we'll hire an appraiser (wink, wink) and buy your house immediately (but no sooner than the minimum Section 121 time period) at FMV", even if the exiting employee will simply turn around and buy the house next door? It seems to me that not only the tax collector but the stockholders might want to know more about the money changing hands as a result of this transaction. I just went and did a quick Google search of "golden parachute relocation" and while mention of relocation assistance or interest-free loans for housing are mentioned, outright purchases are not. The closest I found was something like this: "The Company will make available to Executive the opportunity to sell his present primary residence at appraised value through a relocation firm mutually acceptable to Executive and the Company". The use of a third-party makes more sense to me than the company buying the property outright, and in that case I suspect there would be clearer tax implications. However, it also seems common for firms to gross up the severance payouts to cover taxes, so I guess it's moot in the end (and a much cleaner solution than the one proposed by the OP).

No, of course not....oops, wait, well yes they are taxed on the savings (ignoring section 121 exclusion), since they don't get to deduct any selling expenses in that case. But it still seems like he received something of value from his employer (a "free" real estate transaction) in exchange for services provided as an employee.

Would a Circular 230 practitioner need to disclose a position to the IRS if preparing this return?

-Mark Bole

Reply to
Mark Bole

There is nothing transitory about it.

The bank must do what the contract requires. Based on what was said earlier, I presumed that buying the house at market value was required by the contract. Presumably that was what was done. In that case they were following the contract. Since the original contract was an arm's length transaction, so was performance under that contract. If the employer paid more than market value, that's another story. And as I said before, if they paid more than market value, the excess does not qualify for the $250,000 exclusion. Instead it is taxable as salary.

They're two separate transactions, and have two separate tax effects.

It doesn't. It's just fairly common in those situations.

Those kinds of deals are generally given to people who have to relocate to California, and get sticker shock when they see the price of housing here. It's not limited to that, of course. And if it can be shown that more than fair value was paid, without good reason, the shareholders would certainly have the right to complain. But in my experience that is not what happens.

Every deal is different. The employee may have asked for that to work for the company, and they wanted him enough to give it to him.

What's wrong with that?

Stu

Reply to
Stuart Bronstein

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