Prepared by Worldwide ERC® Tax Counsel, Peter K. Scott
Peter Scott Associates
Current as of January, 2018
The Buyer Value Option, which is a variation of the Amended Value program, is in wide use in relocation home purchase programs.
In a "standard" BVO, the employer does not obtain appraisals of the home nor does it make an initial or guaranteed offer to purchase the home, although it is always understood that the employer intends to purchase the home once the employee has tested the market and, in doing so, received a purchase offer. The employee proceeds to market the home. Broker selection, marketing assistance, home marketing advice, and so forth, are specified in the company policy, and generally would not be different for this home purchase option than for any other option. When the employee selects a broker, the employee’s listing agreement with the broker must include the standard exclusion clause to avoid triggering income to the employee in the amount of the broker commission when the home is sold to the employer.
Once the employee has obtained an offer, that offer establishes the value (the "buyer value"), and that is what the employer offers the employee for the home. Clearly, that value, established by an actual offer from an unrelated buyer, will be respected as fair market value. Thereafter, the process proceeds just as it would in an Amended Value purchase: An unconditional, non-contingent offer is made by the employer to the employee; the employer then attempts to negotiate and close its own sale to the buyer who made the outside offer.
If the employee does not obtain an outside offer within the initial marketing period (which may vary in duration-some programs do not specify a marketing period at all), procedures vary. In some programs, a new marketing period is established, and the process simply is repeated until an outside offer is obtained. In others, at some specified time, the company will convert the transaction to a regular purchase, obtain one or more appraisals, and buy the home from the employee. The latter procedure, sometimes called a “delayed Amended Value,” is much to be preferred from a tax standpoint.
The tax consequences of a BVO are not clear.
After publication in 1972 of Rev. Rul. 72-339, 1972-2 C.B.31, which dealt with an appraised value purchase, IRS had never provided authoritative guidance on any type of home purchase program until 2005. Although it engaged in a lengthy consideration of Assigned Sales and Amended Value sales in 1988, and again in 1994-95, IRS closed its files in both instances without taking a formal position. Finally, in 2005 IRS published Rev. Rul. 2005-74, 2005-51 IRB 1, which establishes that both appraised value and Amended Value transactions, with or without use of a blank deed, result in two separate, independent sales and that most costs are not taxable to the employee. The ruling provides considerable detail as to the procedures the IRS considers acceptable, and is based on the standard Worldwide ERC® program description, which incorporates the “eleven key elements” of an Amended Value transaction. The 11 key elements are also applicable to BVO’s.
The ruling is silent as to the consequences of a BVO, which is not mentioned. Nor does the fact pattern in the ruling include the familiar “offer before appraisal” scenario, from which the BVO program was originally derived. Therefore, caution must be exercised in attempting to extend the favorable IRS conclusion to variations of the Amended Value transaction such as the BVO.
In evaluating the tax consequences of a BVO, roughly the same issues that arise in an Amended Value transaction must be addressed: whether the employer paid expenses the employee was obligated to pay; whether the two sales will be respected as separate and independent; and whether the employer conferred a taxable fringe benefit on the employee by paying the real estate broker commission. The IRS was not troubled by these issues in the favorable holding in Rev. Rul. 2005-74, and there is a good case that the favorable holding should also apply to the BVO, which follows all of the same procedures as an Amended Value sale except for the appraisal process and original guaranteed offer. The argument for favorable treatment of the BVO is as follows:
Rev. Rul. 2005-74 considers three factual scenarios in which a relocating employee sells his home to a relocation management company (RMC) operating on behalf of the employer.
In Situation 1, the RMC determines the value of the employee’s home through appraisals, and makes an offer to purchase the home at that value. The employee accepts the offer. When the employee vacates the home, the employee receives any remaining equity, delivers possession to the RMC, and is relieved of any further cost, risk, maintenance, insurance, or losses. The employee delivers title to the RMC through use of a “blank deed,” which is a deed executed by the employee but with the name of the buyer left blank. The RMC then holds itself out as the owner of the home to the public and anyone with whom it has dealings, lists the home for sale with a real estate broker, and eventually sells the home to an outside buyer, paying all the costs of sale. Any profit or loss on such a sale belongs to the employer.
In Situation 2, the facts are the same as in Situation 1 except that the program includes an “amended value option,” under which the employee lists the home with a real estate broker and markets it to other potential buyers. The broker listing agreement contains an “exclusion clause,” under which the broker will not earn a commission if the home is sold to the RMC. If an offer is received that is acceptable to the employee, the employee does not sign the offered contract, or accept a down payment. Instead, the employee turns the offer over to the RMC for review. If the RMC determines that the offer is bona fide and exceeds the appraised value offer, it “amends” its earlier offer to meet the outside offer price. If the employee accepts the amended offer by signing the contract to sell to the RMC, the RMC lists the home for sale and attempts to enter into its own contract with the outside buyer. The purchase from the employee proceeds as it would in Situation 1, and is unaffected by whether the RMC is able to enter into or close a sale with any particular buyer.
In Situation 3, the facts are the same as Situation 2 except that when the employee receives an outside offer for the home, the RMC is not required to offer a higher “amended” price for the home “unless and until” the RMC has entered into its own contract to sell the home to the buyer who made the offer. The employee is entitled to the proceeds of the sale at the higher price only “if and when” the sale to that buyer closes. And, the employee retains the right to negotiate offers or counteroffers between the RMC and the outside buyer.
The ruling holds that in Situations 1 and 2, there are two separate sales of the home, one from the employee to the RMC, and a second from the RMC to an outside buyer. Costs incurred by the RMC to purchase, manage and sell the home are not income or wages to the employee. In Situation 3, there is only one sale, from the employee to an outside buyer, facilitated by the RMC. All costs are taxable to the employee as wages.
A properly constructed BVO process follows every one of the procedures recited with approval by the IRS in Rev. Rul. 2005-74 in analyzing whether two sales have occurred. It differs structurally from an amended value process only in that no initial appraisals are done, and no initial buyout offer is made based on them. However, the initial offer process included in the ruling is essentially descriptive; it is not relied upon in the analysis portion of the ruling in any of the three Situations.
In a BVO, the same procedures are followed in selecting a real estate broker, pricing and marketing the home, dealing with offers received, making the offer from the RMC based on the outside offer, entering into a contract with the employee, settling with the employee, and handling the RMC’s eventual sale, as are followed in an amended value program.
In analyzing Situations 1 and 2, the ruling cites the following factors as supporting the existence of two separate sales: The parties treat the first transaction as a sale (as evidenced by a contract of purchase and sale between the employee and RMC); on the settlement date, the RMC acquires all of the employee’s interest and equity in the home; the employee does not sign any contract or binder with a third party buyer, or accept a down payment; after purchasing the home the RMC deals with third parties, such as mortgage holders, home maintenance companies, real estate brokers, etc, in its own name as though it were the owner of the home; if a sales agreement with a third party buyer does not close, the RMC remains responsible for all risks and costs and the employee is unaffected; after settlement (with the employee) the RMC has the sole right to possession; the RMC will sustain any loss or benefit from any gain if the purchase price is different than the ultimate sales price; the RMC has the risk of loss due to casualty and is responsible for insuring the property; the RMC is identified as the seller in the outside sales agreement; under no circumstances would the employee be entitled to any part of a gain realized by the RMC on its own sale; and the sale to the RMC is not contingent on the RMC’s sale to the outside buyer.
No part of this analysis in any way depends upon the existence of an original offer to purchase at appraised value. Although the ruling includes an original offer as a fact (which would be a necessary factual element in Situation 1, in which there is merely a purchase by the RMC with no marketing by the employee), no part of the analysis the IRS employs to find that there is a bona fide sale to the RMC in either the appraised value transaction in Situation 1 or the amended value sale in Situation 2 relies on the existence of an original appraised value offer. The analysis focuses exclusively on the transfer of benefits and burdens between the employee and RMC once a contract is in place, and the lack of a relationship between that sale and the RMC’s sale to an outside buyer. As noted, all of those procedures are identical to those employed in a BVO.
The ruling’s lack of reliance on the existence of an original offer in an amended value program is correct, and meaningful.
The marketing and appraisal processes in a standard amended value program ordinarily proceed more or less simultaneously. That is, neither depends upon the other, and marketing by the employee generally will begin before appraisals can be completed and evaluated and an offer made. Employees often receive outside offers that are acceptable to them before completion of the appraisal process. In such instances, the outside offer is processed, and an offer made by the RMC based on the outside price, without appraisals. That is exactly what happens in a BVO, and indeed the BVO process originated from industry observations that appraisals were sometimes a superfluous and unnecessary cost in an amended value program.
The IRS was well aware of this possible fact scenario in an amended value program, which was included in industry submissions to IRS and discussed with IRS personnel. Clearly, the tax outcome of an amended value relocation home purchase program does not and should not depend upon whether the employee received an early outside offer, nor should it require that the appraisal process be taken to a conclusion in such instances.
Consequently, although the IRS did not include the “offer before appraisal” scenario in the facts in Situation 2, it is arguable that the IRS’s lack of reliance on the existence of an initial appraised value offer in its analysis of Situation 2 suggests strongly that the scenario of an offer before appraisal, which was known to IRS, was considered not to have any adverse impact.
As noted, the absence of an initial offer based on appraisals is the only factual difference between the amended value program approved in Situation 2, and a BVO.
Similarly, either an amended value or BVO program may, if organized or operated improperly, have features that suggest the application of Situation 3. But there is nothing about either a properly constructed BVO or amended value program that suggests application of the factors cited in Situation 3, and no difference between the two programs in this respect.
In summary, although the IRS did not specifically rule on BVO programs, either positively or negatively, in Rev. Rul. 2005-74, the procedures utilized in such programs clearly fall exactly within those covered by the favorable analysis of the programs discussed in Situations 1 and 2. Consequently, a BVO program that follows all the approved procedures of an amended value program except for the initial buyout offer based on appraisals should be held to be within Rev. Rul. 2005-74. Two separate sales should be held to have occurred, and costs should not be treated as wages to employees.
Because IRS did not specifically rule on BVO programs, however, there is a significant risk that IRS agents will try to argue that costs in such programs are taxable, and they have already done so in a number of audits.
The possible tax issues in a BVO also are present in an Amended Value transaction, and IRS has chosen not to tax the latter. However, the tax risk clearly is higher in a BVO. That is because in a traditional Amended Value program, the employer will end up owning the home if no outside buyer is found, and the employee clearly will have received no benefit at all, for example, from the employment of a real estate agent. Thus, as noted earlier, IRS acceptance of Amended Value transactions should not be taken to mean it will accept BVOs. Nevertheless, should IRS decide to assert tax in these transactions, there are sound counterarguments that support nontaxability.
The counterarguments are most likely to be effective if the employer scrupulously observes the applicable 11 key elements of an AV transaction and ensures that there is real ownership risk for a significant period. For example, the offer to the employee should be free of any contingency relating to the second sale, and should be made before there is a completed contract for the second sale. The two closings should not occur at the same time, or even very near to one another. And, the amount paid to the employee should not depend on whether the second sale is completed.
Even with these precautions, however, given the lack of definitive authority, companies contemplating BVO transactions should consult their tax advisors.
Because there is no guaranteed buyout offer, a "pure" BVO is inherently more subject to challenge by the IRS, and less likely to be respected, than an Amended Value transaction. Therefore, as mentioned above it is wise to convert all BVO’s to an Amended Value or regular purchase if the employee does not find a buyer within some reasonable time period. For example, if no buyer is found within 90 days, the employer should appraise the home and make a guaranteed offer of the appraised amount or some reasonable percentage of it. The employee may then be given some additional time to market the home, but at some point the employer should buy it at the guaranteed offer amount if no outside buyer is found. This procedure removes the principal additional vulnerability of a BVO, namely that the employer has not done an appraisal and committed to purchase the home, as in Rev. Rul. 2005-74, unless the employee finds a buyer. With a "back-end" guarantee as described here, the employer can show that it must eventually purchase the home, and that the services of the real estate agent are for its benefit, not that of the employee. It can also more clearly establish that the procedures are within those approved in Rev. Rul. 2005-74.
Company must own the homes.
At some point before closing with the outside buyer the company owns the home. This is, perhaps, the most common area of misconception about BVOs. Companies that have not engaged in home purchase programs previously sometimes see the BVO method as merely a way of doing direct reimbursement of home sale costs without the need to gross them up. Nothing could be further from the truth.
The only reason the home sale costs incurred by the company are not considered income to the employee is that these costs are considered to be incurred by the company on its own behalf in completing a sale of property it purchased and owns. Thus, ownership is crucial. Moreover, "ownership" for tax purposes means more than momentary or "paper" ownership. It means that the company must have had real ownership risk, a real investment, real responsibility for the property, for a period that is long enough not to be considered insubstantial. In short, there is no "free lunch" from a tax perspective. The tax advantage obtained by a BVO is neither more nor less than that obtained in a regular purchase or amended value purchase; all require that the company assume the benefits and burdens of real homeownership.
Application of the 11 key elements
It is even more important to adhere to the 11 key elements and procedures of an Amended Value option in a BVO than in a standard Amended Value transaction.
As discussed above, it is crucial for the company to establish its ownership of the home. For that to occur, there must be two separate sales, each respected by the IRS as bona fide: one from the employee to the employer or relocation management company, and a second from that purchaser to the outside buyer.
The 11 key elements were developed in 1985 by Worldwide ERC® to provide a set of guidelines which, if followed, would provide the best likelihood of the two sales being considered separate and independent.
As discussed earlier, a BVO is a variation of an Amended Value purchase. But, from a tax perspective, it is inherently more susceptible to an IRS argument that the two separate sales should not be respected, and that all that has really occurred is a sale from the employee to an outside buyer, with the employer reimbursing the costs. Primarily this is because there is no initial guaranteed buy-out offer. It can be argued that the employer never had any intention of actually owning the home; rather, the employer merely acted as an intermediary to facilitate the employee's sale. Moreover, if the employer will never own the home unless an outside buyer is found, there is an argument that the real estate broker benefited only the employee and that the employer conferred a taxable fringe benefit on the employee by paying the broker commission.
For this reason, BVO programs that convert to a standard Amended Value if no buyer is found are more likely to be respected, as discussed above.
Because of its higher tax vulnerability, in a BVO it is even more important to follow the amended value rules scrupulously. That is, it should be absolutely clear that the employer has incurred real ownership risk for a significant period. Under no circumstances should the program be operated so that closings with the employee and the outside buyer are essentially simultaneous. There generally should be a period of at least a week or two during which the employer is at risk with respect to ownership of the home. Under no circumstances should the offer to the employee be contingent on some aspect of the second sale. For example, the offer never should be contingent on the second sale actually closing, or on the home successfully passing the outside buyer's inspections. Further, the amount ultimately paid to the employee should not be affected by whether the second sale closes.
Unfortunately, too often companies seek to circumvent these procedures in order to reduce the risk of suffering any losses on home purchases. That is, they seek to orchestrate the BVO program so that ownership risk is eliminated. Ultimately, this will be self-defeating because ownership risk is essential to maintaining the desired tax treatment.
As noted above, there is no "free lunch." A direct reimbursement program is taxable to employees, and trying to make it look like a home purchase will not succeed unless it really is a home purchase. Indeed, a number of unpleasant penalties could apply if the attempt is blatant.