Prepared by Worldwide ERC® Tax Counsel, Peter K. Scott
Peter Scott Associates
Current as of January, 2017
During its Webinar held December 5, 2005, to discuss the new IRS revenue ruling (Rev. Rul. 2005-74) on relocation home purchase programs, Worldwide ERC® received many questions related to the ruling, its interpretation, and effects. Other questions have since been received. The following provides the best current judgment of Worldwide ERC® Tax Counsel Peter K. Scott as to the answers to those questions. Some questions have been edited, and/or combined with other questions on a similar topic. And, a few questions are not addressed simply because the answer is unclear and will, in most cases, depend upon future experience as to how the IRS and its agents interpret the ruling.
Worldwide ERC® members are cautioned that these answers are intended as general information only. Regarding their specific situations, Worldwide ERC® suggests that members consult their own tax or legal advisors, as appropriate.
1. Are there any plans to update the “eleven key elements and procedures of an amended value option” in light of Rev. Rul. 2005-74?
Worldwide ERC®’s Public Policy Committee studied the ruling when it was issued, and determined that the procedures described in the ruling are entirely consistent with the “eleven key elements.” The Committee did not believe any expansion or further explanation based on the ruling would be helpful. Worldwide ERC’s Government Affairs Tax Forum, which is now responsible for the issue, regularly reviews it and currently believes no revisions of the eleven key elements are necessary or advisable.
Worldwide ERC® has provided an analysis of the ruling, which is available on the “Tax & Legal MasterSource,” and Worldwide ERC® will continue to provide updated information about the ruling, its interpretation, and any further IRS activity on the issue, in its Tax & Legal Updates, which are distributed four times per year, and in its Mobility LawBlog.
2. What is the status of the 2001 Worldwide ERC® recommendation to use two deeds? Are companies now free to return to the blank deed, and if so, are there states in which the use of two deeds should still be considered?
The ruling makes it clear that use of the blank deed does not adversely affect the conclusion that two bona fide, independent sales have occurred for federal tax purposes. Therefore, taking title by deed is not necessary at the federal level. The IRS will not follow the Amdahl court’s emphasis on the blank deed as a negative factor. Consequently, Worldwide ERC®’s 2001 recommendation, which was intended primarily to protect against a possible adverse IRS conclusion, is no longer applicable for federal tax purposes.
However, the analysis in the ruling is based on the eight-factor test that is commonly applied by IRS and the courts to determine whether a sale has taken place. Although passage of legal title is not determinative, it is one of the eight factors. Consequently, companies whose home purchase program has weaknesses or departs in some significant way from the “eleven key elements” or from the procedures blessed in the ruling should consider whether taking title would help to strengthen the conclusion that the program results in two sales.
With respect to state issues, even before Worldwide ERC®’s 2001 recommendation there were states in which two deeds were commonly used, for a variety of reasons. For example, Washington and New York states both exact two transfer taxes regardless of whether two deeds are filed. Consequently, many companies chose to avail themselves of the extra legal protection afforded by taking formal title in those states because there was minimal additional cost incurred to do so. There are other states where taking title should still be considered, for various reasons. This topic is addressed in detail in the MasterSource under “Blank Deed: State Issues and Rev.Rul. 2005-74.” In addition, in 2014 members of the Worldwide ERC Government Affairs Real Estate and Mortgage Forum completed an extensive examination of factors potentially affecting deeding in each state. A chart summarizing that research is available on the Worldwide ERC website, and is regularly updated.
3. Does Rev. Rul. 2005-74 affect Assigned Sales?
The ruling does not discuss assigned sales. However, it is clear from the facts and the analysis employed that the IRS would consider costs incurred in an assigned sale taxable to employees. That conclusion is consistent with the position IRS has taken in numerous prior Private Letter Rulings, and with the advice Worldwide ERC® has provided to its members for many years. In the favorable amended value fact pattern in the ruling (“situation 2”) the ruling is careful to note that the employee does not sign a contract with an outside buyer, or accept a deposit or down payment. Moreover, many of the other facts relied upon by IRS in the favorable amended value fact pattern in the ruling are not present in an assigned sale, including, for example, payment of all the employee’s equity based on the outside sale price at closing with the employee. Nor is the analysis of that fact pattern consistent with an assigned sale.
On the other hand, the facts and analysis in the unfavorable fact pattern in the ruling (“situation 3”) are consistent with both a poorly structured amended value program and with an assigned sale.
Consequently, the ruling should be considered to treat assigned sales as resulting in taxable income to employees. As noted, IRS has always considered assigned sales taxable, and presumably will continue to do so.
4. Are companies required to follow Rev. Rul. 2005-74?
No. A revenue ruling is simply an expression of the IRS position as to how the law applies to a particular set of facts. The IRS itself must follow the ruling, and taxpayers are entitled to rely upon it in structuring their affairs. Courts, however, do not treat revenue rulings as authority in favor of the IRS, but simply as reflecting the IRS’s litigating position. As long as a company has substantial authority for its position, it will not be penalized for failing to follow the IRS ruling.
However, most companies will want to do so. As noted, IRS agents will follow the ruling, and will assert employment tax liability on audit if the taxpayer is not doing so. Companies can avoid the time, cost, and uncertainty of defending an IRS audit by reforming their procedures to those found acceptable in the ruling.
5. Would all transfer taxes now be considered nontaxable and not reportable under the ruling?
The ruling does not detail the costs incurred to buy and sell the employee homes, but states as a fact that the relocation management company “pays the settlement costs that are typically imposed on a buyer under local law.”
The ruling is silent as to any costs incurred that are seller obligations under local law or custom. However, the longstanding position of the IRS is that if such costs are incurred on the sale from the transferee to the employer or relocation management company, and are paid by the latter, they are taxable to the transferee. The rationale is that the employer has paid a cost for which the employee was liable.
Nothing in the ruling suggests that the IRS has changed its position on such costs, and the limitation to buyer costs in the factual recitation quoted above indicates that IRS was careful not to suggest such an interpretation.
Consequently, in situations (unlike the ruling) in which two deeds are used, if transfer taxes or recording fees are incurred on the first transaction that are seller costs under local law or custom, those costs should be considered taxable to the employee. For a more detailed discussion of the taxability of such transfer taxes, see “Seller Costs Taxable (Transfer Taxes)” in Worldwide ERC®’s Tax & Legal MasterSource.
6. How does the ruling affect the Buyer Value Option program, if at all?
Rev. Rul. 2005-74 does not address the BVO program. Although Worldwide ERC® included in its submission to the IRS a BVO process when the employee receives an offer prior to appraisal, the IRS chose not to include either those facts or that term in the final ruling. The reason for that omission is unknown, but the omission should not be taken to reflect an opinion on the part of IRS with respect to BVO’s, either favorable or unfavorable.
The procedures that the IRS has approved for an Amended Value program are, once the employee begins marketing and receives an offer, exactly the same as those used in a BVO. That is, 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. Consequently, companies have a strong position, based on the ruling, that their BVO program is merely a type of Amended Value, and that non-taxability of the costs is fully supported by the ruling, provided the same procedures are being followed. The industry is in a far stronger position with respect to BVO’s after the ruling than it was before, even though BVO’s are not specifically addressed. However, in some IRS audit locations agents have taken the position that a BVO is not within the ruling, and challenged the tax treatment. Companies whose BVO program conformed to the “eleven key elements” have had some success in resisting this contention, while companies whose programs do not conform, or whose programs have procedures resembling “situation 3” in the ruling, or have incorporated suspect risk reduction techniques that result in the two settlements being very close together, have generally had some additional taxes imposed.
Like companies conducting Amended Value programs, companies with BVO’s should immediately undertake a review of their program procedures to compare them with those approved in Rev. Rul. 2005-74. If the procedures being followed depart significantly from the “eleven key elements,” or include some or all of the features incorporated by IRS in the unfavorable “situation 3” in the ruling, companies should consider whether they wish to change those procedures in order to achieve the tax certainty afforded by following the ruling, or are willing to take the risk that their program may be successfully challenged by the IRS.
However, Worldwide ERC® has always cautioned members that a BVO program, which lacks the initial appraisals and guaranteed buyout characteristic of an Amended Value program, carries a higher risk of a challenge from the IRS than an AV, and the attitude of the IRS National Office, should it ever directly address the BVO, is unclear. As noted, the principal weakness in a BVO is the lack of a guaranteed buyout. Consequently, it has always been advisable to structure a BVO 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. For example, the program might be structured so that after 90 days of marketing, if no outside offer has been received the employer will place a value on the house, usually through appraisals, and make an offer to purchase at some realistic percentage of the appraised value, such as 90%. If the employee is unable to find a buyer within some additional reasonable marketing period, such as 60 days, then the employee can accept the employer’s offer.
Such a delayed Amended Value procedure would more closely reflect the procedure approved in the new ruling, and also address the principal weakness in a BVO. It has uniformly been accepted by IRS in those audits brought to ERC’s attention.
Companies may also wish to consider whether continued use of two deeds would help to support their BVO program, particularly if it significantly departs from the procedures approved by the IRS in Rev. Rul. 2005-74 or does not conform to the “eleven key elements.”
7. The IRS included in the ruling a fact pattern (situation 3) in which costs are taxable. Please discuss that fact pattern, and what companies should do in response.
Situations 1 and 2 in Rev. Rul. 2005-74 describe, respectively, an Appraised Value program, and an Amended Value program. The facts stated conform to the standard program descriptions published by Worldwide ERC® in 1985, to the submission made by Worldwide ERC® in 2004, and to the “eleven key elements and procedures of amended value option,” also developed by Worldwide ERC® in 1985.
Situation 3 in the ruling describes an amended value option that does not conform to those standards in a number of respects, and which the IRS says does not result in two separate sales, but rather results in the transaction being treated as a sale by the employee to an outside buyer, with the employer, through a relocation management company, paying the costs. Such costs would be fully taxable to the employee, and subject to withholding and payroll taxes.
The differences can be summarized as follows: The relocation management company (company Z, in situation 3) “is not required to offer a higher, amended value …unless and until Z enters into a sales contract” with the outside buyer; the employee “retains the right to approve or reject any offer or counter-offer made in the course of negotiations between Z and the third party buyer;” and “the proceeds representing the higher amended value are distributed to the employee…only if and when the sale to the third party buyer closes.”
In its analysis of this fact pattern, IRS says that the transaction differs significantly from the amended value transaction described in situation 2, in that “the sale…to Z…at the higher amended price is contingent on Z entering into a contract at that price” with the outside buyer, and that the employee “effectively retains the rights to negotiate the final contract and obtain the benefit of a higher price for the property.”
Taken together, these statements are subject to a number of interpretations. Moreover, it is not clear whether the IRS considers each of the “negative” facts it recites to be a problem in isolation, or whether it is the combination that is fatal.
However, it seems likely that IRS was attempting to describe a situation in which the first sale (from employee to employer) is contingent in some way on the second sale occurring, and in which the employee retains control over the second sale even after a contract is entered into between the relocation management company and the outside buyer. Other interpretations are, of course, possible, and it remains to be seen how IRS personnel will interpret the ruling in practice.
It is also worth noting that the IRS objection is couched in terms of a program structure that includes the negative practices. Consequently, if a program is not structured to include these elements, but one of them happens to occur in a particular file or files because of unusual circumstances, that alone should not cause the program to fail.
In light of the ruling, certain practices that have become common in both Amended Value and BVO transactions should be reexamined, and companies should consider whether any additional costs and risks that might be associated with conforming more closely to the standard amended value procedures should be accepted in exchange for avoiding the time, costs, and uncertain outcome of an IRS audit challenge.
For example, a fairly common practice is to delay entering into a contract with the employee until the employer has successfully entered into a contract with the outside buyer, and the inspection contingencies in that outside offer have been satisfied. As part of this process, the employee is typically allowed to determine whether repairs or other concessions sought by the buyer should be accepted, negotiates those items, and pays for any extra cost. This practice has been justified as necessary to determine the true cash value of the outside offer, but is brought into serious question by the facts and analysis in situation 3 in the new ruling. Regardless of its justification, the practice should be considered questionable in light of the ruling. Audit experience since issuance of the ruling is that IRS agents almost always consider this practice to place the program in question within situation 3, rather than the favorable situation 2.
Similarly, in some programs the company delays funding some or all of the employee’s equity until the second sale closes. This practice has always been ill advised, since it suggests that the first sale is contingent on the second and also eliminates an element of ownership risk (that is, paying the full purchase price at settlement). The ruling, in emphasizing this issue in situation 3, makes it clear that funding delay is a negative factor that could cause a program to fail.
The facts recited in the ruling are not exactly clear as to whether all equity is delayed, or only the portion related to the higher amended value. However, whichever is intended, it is clear that delaying payment until after the outside sale has closed of any portion of the equity, after the amount due is established and settlement with the employee has occurred, would fall within this negative factor.
In some cases, a portion of equity is paid under an equity advance. However, even where all or part of the equity is advanced under a purchase contract with the employee, the employee is subject to repaying the money if the sale does not close. An advance of equity, although not a loan, is not the same as a final payment of equity at settlement. Only if the employee is unequivocally entitled to and receives all his equity by the time he vacates the home or the contract is effective (whichever is later, that is, the typical relocation transaction settlement date) should companies be comfortable that IRS will not assert that payment of equity is unacceptably delayed in a manner similar to situation 3.
This is not to say that equity must be paid at the instant of closing. It is not uncommon for a short period to be necessary to calculate final prorations, and for money to be transferred. However, it is not good practice to structure a program so that equity is not paid until after the proceeds of the outside sale are received. Situation 3 of Rev. Rul. 2005-74 makes it clear that if the employee only receives proceeds representing the higher amended value “if and when” the sale to the third party closes, IRS will view that as a factor inconsistent with the existence of two separate sales.
Finally, companies will need to consider the issue of employee involvement in negotiations.
The employee will always be involved in initial negotiations with the buyer, that is, negotiations necessary to produce a signed offer that is satisfactory to the employee. It does not seem likely that this sort of negotiation is what the IRS objects to. Rather, the facts in situation 3 make it fairly clear that it is employee negotiations and involvement after the relocation management company signs a binding contract with the outside buyer that the IRS considers suspect. Such involvement makes it appear that the relocation company is merely contracting on behalf of the employee, and not itself.
Consequently, as noted above, companies should reexamine the practice of involving the employee in negotiations over repairs and concessions after signing of the outside contract, and consider conducting their own inspections prior to entering into a contract with an outside buyer. Even if the employer’s contract with the employee was made subject to inspections, when the inspections utilized are those of the outside buyer, and the employee negotiates with that buyer through the employer or relocation management company to resolve repair and other issues after the employer or relocation management company has its own sale contract in place, it is likely based on Rev. Rul. 2005-74 that the IRS will consider this evidence that the real seller is the employee, and seek to tax the costs incurred to him.
Note in this regard that the standard program descriptions created by Worldwide ERC®, and accepted in the industry for over 20 years, both say with regard to the employer’s offer to the employee based on the outside buyer offer that “this offer from the (employer) …is unconditional and is not contingent on any event.”
8. May the contract with the outside buyer be contingent on the employer or relocation management company becoming the owner of the property?
It is common practice for the employer or relocation management company to include in its contract addendum with the outside buyer a provision that the contract is contingent on the employer or relocation management company becoming the owner of the property.
Such a provision remains appropriate, and is not affected by the ruling.
This provision does not mean that the purchase from the employee is contingent on the second sale, as in situation 3 in the ruling. Rather, it means just the opposite; that the outside sale is contingent on the company being able to complete its purchase from the employee. It protects the company from situations in which the employee is unable to deliver the home (for example, there is a fatal title defect), or the sale to the company falls through for some other reason (for example, cancellation of the relocation). Without this clause, the company would be obligated to complete a sale of property it does not own.
9. Does Rev. Rul. 2005-74 say anything about the employer’s deduction for the costs of purchase and sale, or whether it is affected by pricing methods such as a fixed fee? What position will IRS take in the future on the employer’s deduction?
Rev. Rul. 2005-74 is silent as to the character of the deduction the employer may take for the costs of purchase and sale.
In situations 1 and 2, in which there are two separate, independent sales, the facts in the ruling are that the transactions are done by a relocation management company, but that the employer is liable for all the costs, and for any losses incurred, and is entitled to all the proceeds of sale. That is, the pricing is what is commonly known as “cost plus.” The IRS says that the relocation management company is acting as the employer’s agent, and that the burdens and benefits of ownership are transferred to the employer. The employer, and not the relocation management company, is the real buyer and owner of the homes.
Under such circumstances, the IRS has since 1982 taken the position that the employer bought and sold a capital asset (the employee’s home), and that the costs incurred give rise to a capital loss, which is deductible only against capital gain. See Rev. Rul. 82-204. Although the new ruling does not reiterate this conclusion, nothing in the ruling suggests that IRS will abandon the position, or casts any doubt on IRS’s continued adherence to Rev. Rul. 82-204. Consequently, IRS agents should be expected to contend that expenses give rise to capital losses in situations where they agree two sales have occurred.
Worldwide ERC® has always considered Rev. Rul. 82-204 to be wrong, and believes that the majority of member companies do not follow it. Worldwide ERC® has advised members for many years that in its opinion there is a strong argument that the houses are not capital assets at all, but rather are property held for sale in the ordinary course of a trade or business. Such assets are excluded from the definition of capital assets under section 1221(a)(1) of the Code, and losses incurred are ordinary losses, deductible against all income. Worldwide ERC® has long hoped that the issue would be litigated and decided. Unfortunately, when it was presented squarely in the Amdahl case, the court avoided it by finding that the employer did not make a bona fide purchase (thus acquiring no asset, capital or otherwise), triggering the employment tax audits that led to Rev. Rul. 2005-74.
For more on this topic, members may refer to the subject “Capital versus Ordinary Loss” in the Worldwide ERC® Tax & Legal MasterSource.
Fixed fee is a pricing method under which the employer pays one fixed amount per home, usually a percentage of the home value, and the relocation management company is responsible for all costs and losses, and entitled to all profits. The federal government’s own relocation programs employ this pricing method.
The IRS, in a Private Letter Ruling several years ago, took the position that in such circumstances the employer is not the owner of the home. Rather, the relocation management company is the owner. It follows from that conclusion that the fee paid is deductible by the employer as an ordinary and necessary business expense, and does not give rise to a capital loss.
As noted, the new ruling is based upon a cost-plus pricing method, and does not mention the fixed fee method. However, nothing about the ruling suggests the IRS has or will change its informal conclusion that in fixed fee programs the relocation management company is the owner.
On the other hand, the ruling analysis with respect to whether the burdens and benefits of ownership are obtained by the relocation management company would apply regardless of the method used by that company to price its services. That is, under either a fixed fee or 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. Consequently, both the favorable and unfavorable situations in Rev. Rul. 2005-74 apply equally to both fixed fee and cost-plus pricing methods. For example, if a contractor performing home purchase services for the federal government did so in the manner outlined in situation 3 in the new ruling, the IRS would assert that the government agency for whom the employees worked is liable for withholding and payroll taxes on the costs.
10. Does Rev. Rul. 2005-74 require any holding period for the houses, and if not, is any period of time between the two sales required?
The facts recited in Rev. Rul. 2005-74 do not include any period of time between the two sales. There is no explicit or implicit holding period requirement stated in the ruling.
However, under federal tax law it is clear that regardless of whether the benefits and burdens of ownership are passed, a purported sale will not be respected if ownership is so fleeting that those burdens and benefits are not real. If property is transferred twice within 10 minutes, the first transfer undoubtedly will be ignored because the “ownership” did not entail any actual risks, burdens, or benefits.
Nothing about the new ruling suggests that IRS would not apply this principal in appropriate circumstance to relocation home sale transactions.
Consequently, companies must still be concerned about procedures that routinely result in purchases and sales occurring very close together. Inevitably, in every program, there will be some instances when the transactions occur close together, simply because the first sale does not close until the employee vacates the home, and the employee did not do so until just before the second closing. However, these instances are explainable as caused by circumstances not imposed by the employer or inherent in the relocation program.
More problematic are programs whose procedures are aimed at insuring that the closing with the employee will always be at or near the time of the closing with the outside buyer, thus limiting the period of ownership risk to a very short period of time. Audit experience since issuance of the ruling is that IRS invariably asks for a complete list of all acquisition and sale dates, and challenges programs which are structured to produce a short holding period, particularly if the procedures used to insure that the holding periods are short (for example, delaying signing a contract with the employee until all contingencies are removed from the outside sale contract and only three days remain until closing) are viewed as falling within the unfavorable situation 3 in Rev. Rul. 2005-74.
Consequently, although there is no particular holding period required, the holding period can still be an issue, particularly if procedures are in place to force a short one. Companies would generally be well advised not to adopt such procedures.
11. Is the employer required to pay off the employee’s mortgage at settlement with the employee?
No. The facts recited in favorable situation 1 of Rev. Rul. 2005-74, dealing with an Appraised Value program, specifically state that the employer “may assume, take subject to, or otherwise become responsible for any outstanding mortgages, liens, and encumbrances.”
This language has the effect of eliminating an objection to these programs IRS has sometimes voiced in the past, namely, that the employee remains technically liable on the mortgage even after the sale to the employer until the employer sells the house and pays it off. The ruling indicates that IRS is now convinced that this is not a problem. This is a very positive development, eliminating one common area of controversy with IRS agents.
12. Should the employer’s offer be accepted by the employee in an Amended Value or Buyer Value Option program prior to the employer entering into a listing agreement with a real estate agent for the outside sale? Does it matter if the employer’s listing is with the same agent as the employee, or if the employee is required to select an agent from a list provided by the employer?
The employer or relocation company must enter into its own listing agreement in order to sell the home. Otherwise, once that sale closes the agent will have earned a commission under his or her original listing agreement with the employee, and the employer will be considered to have paid a cost for which the employee was liable.
Rev. Rul. 2005-74, in reciting the procedures in situation 2 (the favorable amended value scenario) says that “if the employee accepts the amended offer by signing the contract of sale, Y (the relocation management company) then enters into a new listing agreement with a real estate broker, customarily the broker previously selected by the employee.”
This statement assumes that there is an accepted offer before a new listing agreement.
Likewise, the Program Definitions for both an Amended Value Option and a Buyer Value Option created by Worldwide ERC® many years ago also say that the employer’s listing agreement occurs after the employee signs the sale contract. This is consistent with the operation of the exclusion clause, under which the employee’s listing with the agent does not terminate until the employee sells the house to the employer.
Consequently, if the employee first lists the home himself, the standard procedure is for the employer to list the home after the employee has accepted the employer’s offer, and the employee’s listing agreement has terminated.
Note that Rev. Rul. 2005-74, in the language above, eliminates an issue that has been raised periodically in the past by the IRS, that is, whether the fact that the employee’s real estate agent usually gets the listing from the employer suggests that the agent really earned the commission from the employee. IRS now seems convinced that this is not a problem, which will eliminate yet another issue sometimes raised by IRS agents.
Moreover, the ruling also includes the following statement: “the employee must select the broker from a list of qualified brokers maintained by Y (the relocation company).” Again, this statement indicates IRS acceptance of a common practice that it had sometimes questioned in the past.
13. How will Rev. Rul. 2005-74 affect the timing of payment for homesale incentives? Can the bonus be contingent on the second sale closing?
The facts in Rev. Rul. 2005-74 do not include payment of a bonus for finding a buyer. Nothing in the ruling suggests that IRS considered the tax treatment of bonuses, or their timing.
However, Worldwide ERC® has suggested for some years that making a bonus for finding a buyer contingent on the sale to that buyer closing is inconsistent with the “eleven key elements” in that it creates an unacceptable linkage between the two sales. For further discussion of this issue, see “Bonus Timing in a Home Purchase Program” in Worldwide ERC®’s Tax & Legal MasterSource.
Nothing in the ruling suggests any change to Worldwide ERC®’s analysis that making the bonus contingent on the second sale would violate the “eleven key elements”, and the emphasis in the ruling on not involving the employee in the second sale, as well as the disapproval of making the first sale contingent on the entering into a contract for the second, suggests that Worldwide ERC®’s analysis is correct.
In short, a bonus earned for finding a buyer should be payable whether or not the outside sale closes.