Tax Problem from Sale of Residence

In 2004 while no longer MD residents, what had been our primary residence was sold and should have been exempt from Capital Gains. However, due to some new regulations that the settlement attorneys did not understand, an amount of about $16K was taken from the sale. After many calls to MD tax offices, we were advised that the best course was to file a MD nonresident return for 2004: MD income = 0, Tax withheld = 16K, Refund due = 16K, and the money was finally refunded.
The problem is, this refund has been reported to the IRS as 2005 income. It appears that one way to deal with this would be to file an amended Federal form for 2004 and claim an additional $16K deduction to balance out the added income on the 2005 tax. Hopefully, the refund from 2004 would more or less equal the additional 2005 tax. But, is there any more simple way to handle this. We were just getting back wrongfully withheld funds and never thought of including it on the 2004 Federal forms.
Dave
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Reply to
davesvideo

As long as the $16K was not used on your 2004 return to gain a tax benefit, receipt of the refund is not taxable income. Ignore it.
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Reply to
Herb Smith

Yes, a more simple way to handle it is to not report any state tax refund income on your 2005 return (except for any refunded amount you actually deducted in '04). Show a zero on the appropriate block of Form 1040 and write "Tax Benefit Rule" in the space to the left of the amount block.
Good luck.
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Reply to
Bill Brown

That's what we decided to do, but since the state of MD has reported this as arefund to the IRS, I figure that an audit is a certainty. We were hoping to avoid that.
Dave
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Reply to
davesvideo

Leaving this off your return is not an invitation to IRS to take a look at your return. For one thing, they don't have the manpower to look at every return like this. Thousands of taxpayers don't itemize but still ger state tax refunds. If IRS had to look at all of these, they wouldn't have time to check anything else.
Lanny K. Williams, CPA Nawarat, Williams & Co., Ltd. Income Tax Services for Expatriate Americans
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Reply to
L K Williams

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