ALTA® Prevails; IRS Allows Capital Gains Certification in Place of Most 1099-S Reporting

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May/June 1998 - Volume 77, Number 3

While ALTA® and its members have recommended "plain English" changes to the certification, the atlernative proposed by the IRS can be used now.

Sustained lobbying by ALTA® to change the law and regulations applicable to Form 1099-S reporting has obtained results. Early in February, the Internal Revenue Service issued a capital gains certification that may, in most instances, be used as an alternative to Form 1099-S reporting for sales and exchanges of residential property. ALTA® has estimated that, if properly implemented, the industry could reduce filings by 75 percent. While ALTA® and its members have recommended "plain English" changes to the certification to eliminate sellers current fear of signing the certification, the alternative proposed by the IRS can be used now. ALTA® will notify members if a plain English alternative endorsed by the IRS becomes available later this year.

The 1986 Tax Reform Act required "reporting persons" to file information reports (on Form 1099-S) on "sales or exchanges" of reportable real estate, including improved and unimproved land, residential, commercial or industrial buildings, condominium units, and stock in co-operative housing units. In 1992, reporting was added for state real property tax proration amounts.

In general, the Taxpayer Relief Act of 1997 eliminates Form 1099-S reporting for sales of principal residences of $250,000 or less ($500,000 for sellers who are married). The reporting relief is a companion provision to an expanded exclusion of gains from such sales from gross income. Under the Taxpayer Relief Act, American homeowners can exclude up to $250,000 of capital gains when they sell their home if they are single, and up to $500,000 of capital gains if they are married and file jointly. While ALTA® originally sought elimination of the reporting requirement, on the grounds that, on average, it would take around a $1 million property to generate $500,000 in capital gains, Congress refused to consider that alternative. First, despite Chicago Title research to the contrary, both Congress and the Administration had an expectation that there actually were many properties that had more than $500,000 of capital gains. Second, the Taxpayer Relief Act also included provisions broadening the definition and therefor the availability of the home office deduction. This change and ongoing rental use meant that many more properties, which are technically residential, may be used for business purposes.

Sec. 312 of the "Taxpayer Relief Act of 1997" (P.L. 105-34, 111 Stat .788, August 5, 1997) provides that real estate reporting persons generally need not file information reports (Form 1099-S) for sales or exchanges of principal residences with a sale price at or below $250,000 for a single individual (or at or below $500,000 if the seller is married), as long as the reporting person obtains a certification from the seller in a form acceptable to the Secretary of the Treasury.

The IRS guidance (Rev. Proc. 98-20, 26 C.F.R. 601.602: Tax Forms and Instructions) establishes a framework for the certification and a sample certification form. However, the requirements may be met if the content and wording of a substitute certification meet the IRS information requirements noted below.

Key elements:

Certification: The certification is in writing, signed by the seller under penalties of perjury, and assurances are made that:

• the seller owned and used the principal residence for two of the last five years;
• the seller has not owned or exchanged another principal residence during this two year period;
• no portion of the residence has been used for business or rental purposes; and
• the sale price, capital gains, and marital status filing requirements are met.

Based on conversations we have had with the IRS in alerting them to problems the industry has had implementing the certification, we also recommend that:

• each individual seller signs a separate certification,
• all boxes must be checked.
• any one of the filing status assurances may be met (see Box 4)

Closers may modify the certification on their own desktop publishing system, but the boxes to be checked, and the substantive language of the IRS certification should be retained. It is possible, for example, to develop a one-page cover sheet explaining the certification to sellers. ALTA® has also pointed out that the double negatives in assurances 2 and 3 are confusing to most sellers and should be modified. Consequently, the IRS has indicated that closers could expand the explanation of the assurances. For example, it would be acceptable to add in assurance 2, which describes the statutory requirement that the seller has not taken a similar exclusion in the last two years, a sentence that this sale would be the only sale of principal residence the seller has made within the last two years.

The certification must be obtained at any time on or before January 31 of the year following the sale or exchange, and retained in your files for 4 years.

For sales between May 7, 1997 and December 31, 1997, the real estate reporting person may alternatively, but is not required to, obtain a certification on or before February, 28, 1998.

Keep in mind that a closer can always continue to file a Form 1099-S, but obtaining a certification eliminates the need to file the form, and does not expose a company to possible penalties for incorrect filings.