Alien Status

For tax purposes, an alien is an individual who is not a U.S. citizen. An alien is in one of three categories: resident, nonresident, or dual-status. Placement in the correct category is crucial in determining what income to report and what forms to file.

Most members of the Armed Forces are U.S. citizens or resident aliens. However, if you have questions about your alien status or the alien status of your dependents or spouse, you should read the information in the following paragraphs and get Publication 519.

Under peacetime enlistment rules, you generally cannot enlist in the Armed Forces unless you are a citizen or have been legally admitted to the United States for permanent residence. If you are an alien enlistee in the Armed Forces, you are probably a resident alien. If, under an income tax treaty, you are considered a resident of a foreign country, see your base legal officer. Other aliens who are in the United States only because of military assignments and who have a home outside the United States are nonresident aliens. Guam and Puerto Rico have special rules. Residents of those areas should contact their taxing authority with their questions.

Resident Aliens

You are considered a U.S. resident alien for tax purposes if you meet either the green card test or the substantial presence test for the calendar year (January 1 - December 31). These tests are explained in Publication 519. Generally, resident aliens are taxed on their worldwide income and file the same tax forms as U.S. citizens.

Treating nonresident alien spouse as resident alien.   A nonresident alien spouse can be treated as a resident alien if all the following conditions are met.

• One spouse is a U.S. citizen or resident alien at the end of the tax year.
• That spouse is married to the nonresident alien at the end of the tax year.
• You both choose to treat the nonresident alien spouse as a resident alien.

Making the choice.   Both you and your spouse must sign a statement and attach it to your joint return for the first tax year for which the choice applies. Include in the statement:

• A declaration that one spouse was a nonresident alien and the other was a U.S. citizen or resident alien on the last day of the year,
• A declaration that both spouses choose to be treated as U.S. residents for the entire tax year, and
• The name, address, and taxpayer identification number (social security number or individual taxpayer identification number) of each spouse. If the nonresident alien spouse is not eligible to get a social security number, he or she should file Form W-7, Application for IRS Individual Taxpayer Identification Number,(ITIN). ITINs may be available through the nearest overseas base legal office or U.S. consulate.

Once you make this choice, the nonresident alien spouse's worldwide income is subject to U.S. tax. If the nonresident alien spouse has substantial foreign income, there may be no advantage to making this choice.

Ending the choice.   Once you make this choice, it applies to all later years unless one of the following situations occurs.

• You or your spouse revokes the choice.
• You or your spouse dies.
• You and your spouse become legally separated under a decree of divorce or separate maintenance.
• The Internal Revenue Service ends the choice because of inadequate records.

For specific details on these situations, get Publication 519.

If the choice is ended for any of these reasons, neither spouse can make the choice for any later year. This applies to a divorced individual who previously made the choice and later remarries.

Choice not made.   If you and your nonresident alien spouse do not make this choice:

• You cannot file a joint return. You can file as married filing separately, or head of household if you qualify.
• You can claim an exemption for your nonresident alien spouse if he or she has no gross income for U.S. tax purposes and is not another taxpayer's dependent (see Exemptions, later).
• The nonresident alien spouse generally does not have to file a federal income tax return if he or she had no income from sources in the United States. If a return has to be filed, see the next discussion.
• The nonresident alien spouse is not eligible for the earned income credit if he or she has to file a return.

Nonresident Aliens

An alien who does not meet the requirements for resident alien, as discussed earlier, is a nonresident alien. If required to file a federal tax return, nonresident aliens must file either Form 1040NR, U.S. Nonresident Alien Income Tax Return, or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents. See the form instructions for information on who must file and filing status.

Nonresident aliens generally must pay tax on income from sources in the United States. A nonresident alien's income that is from conducting a trade or business in the United States is taxed at graduated U.S. tax rates. Other income from U.S. sources is taxed at a flat 30% (or lower treaty) rate. For example, dividends from a U.S. corporation paid to a nonresident alien generally are subject to a 30% (or lower treaty) rate.

Dual-Status Aliens

An alien may be both a nonresident and resident alien during the same tax year, usually the year of arrival or departure. Dual-status aliens are taxed on income from all sources for the part of the year they are resident aliens. Generally, they are taxed only on income from sources in the United States for the part of the year they are nonresident aliens.

Exemptions

Exemptions reduce your income before you figure your tax. There are two types of exemptions.

• Personal exemptions.
• Exemptions for dependents.

While both types of exemptions are worth the same amount, different rules apply to each.

You generally can claim one exemption for yourself. If you are married and file a joint return, you can claim your own exemption and one for your spouse. If you file a separate return, you can claim the exemption for your spouse only if your spouse had no gross income and was not a dependent of another taxpayer. You also can claim one exemption for each person qualifying as your dependent who meets five specific tests.

You may be eligible to claim an exemption for a child, even if the child has been kidnapped. See Kidnapped children under Exemptions for Dependents in Publication 501.

For 2002, you generally can deduct $3,000 for each exemption you claim for yourself, your spouse, and each person who qualifies as your dependent.

If another taxpayer can claim an exemption for you or your spouse, you cannot claim that exemption on your tax return. If you can claim an exemption for a dependent, that dependent cannot claim an exemption on his or her own tax return.

To claim an exemption for a dependent on your tax return, you must list either the social security number (SSN), individual taxpayer identification number (ITIN), or adoption taxpayer identification number (ATIN) for that person on your return.

For more information on exemptions, see Publication 501.

If you do not list the dependent's SSN, ITIN, or ATIN, the exemption may be disallowed.

Dependents

A dependent is a person, other than you or your spouse, who meets the dependency tests. You can claim a dependency exemption if all five of the following tests are met.

1. Member of household or relationship test. To meet this test, the person must either live with you for the entire year as a member of your household or be related to you in one of the ways listed under Relatives who do not have to live with you, in Publication 501.
2. Citizen or resident test. To meet this test, the person must be a U.S. citizen or resident, or a resident of Canada or Mexico for some part of the calendar year in which your tax year begins. Children are usually citizens or residents of the country of their parents.

   If you were a U.S. citizen when your child was born, the child may be a U.S. citizen although the other parent was a nonresident alien (see Alien Status, earlier) and the child was born in a foreign country.

   You can claim your child's exemption if the child is a U.S. citizen and meets the other tests. It does not matter that the child lives abroad with the nonresident alien parent.

   If you are a citizen or national of the United States and you legally adopt a child who is not a U.S. citizen or resident, you can claim the child's exemption if:

   1. The other tests are met,
   2. The child had your home as his or her main home for the year, and
   3. The child was a member of your household for the year.
      Example. Sergeant John Smith is a U.S. citizen and has been in the U.S. Army for 16 years. He is stationed in Germany. He and his wife, a German citizen, have a 2-year old son who was born in Germany and who has dual citizenship (U.S. and Germany). Sergeant Smith's stepdaughter, a German citizen whom he has not adopted, also lives with them. Only his son can be considered a U.S. citizen for whom a dependency exemption can be claimed. His stepdaughter does not qualify as a U.S. citizen or resident.
3. Joint return test. Even if the other dependency tests are met, you generally are not allowed an exemption for your dependent if he or she files a joint return. However, the joint return test does not apply if a joint return is filed by your dependent and his or her spouse merely as a claim for refund and no tax liability would exist for either spouse on separate returns.
4. Gross income test. To meet the gross income test, the person must have gross income of less than $3,000. This test does not apply if the person is your child and is either under age 19 at the end of the year, or under age 24 at the end of the year and a full-time student during 5 calendar months of the year.
5. Support test. To be considered your dependent, the person generally must receive more than half of his or her support from you during the year. To figure if you provided more than half the support of a person, you must first determine the total support provided from all sources for that person.

Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.

Generally, the amount of an item of support is the amount of the expense incurred to provide it. If the item is lodging, the amount of the item is the fair rental value.

Expenses that are not directly related to any one member of a household, such as the cost of food for the household, must be divided among the members of the household.

Divorced or separated parents.   Different rules apply to the support test for children of divorced or separated parents. These rules are discussed in Publication 501.

Dependency allotments.   You can authorize an allotment from your pay for the support of your dependents. The amount is considered as provided by you in figuring whether you provide more than half the dependent's support.

If an allotment is used to support persons other than those you name, you can claim exemptions for them if they otherwise qualify as your dependent.

Example.   Army Sergeant Jeff Banks authorizes an allotment for his widowed mother. She uses the money to support herself and Jeff's 10-year-old sister. If that amount provides more than half their support, Jeff can claim an exemption for each of them, if they otherwise qualify, even though he only authorized the allotment for his mother.

Dependent in the Armed Forces.   Generally, an exemption cannot be claimed for a person who is in the Armed Forces or is at one of the Armed Forces academies for the entire year because the support test will not have been met. However, if your dependent receives only partial support from the Armed Forces, you can still claim the exemption if you provided more than half his or her support and the other tests are met.

Example.   Leslie James is 18 and single. She graduated from high school in June 2002 and entered the U.S. Air Force in September 2002. Leslie provided $4,400 (her wages of $3,400 and $1,000 for other items provided by the Air Force) for her support that year. Her parents provided $4,100. Her parents cannot claim a dependency exemption for her for 2002 because they did not provide more than half her support.

Sale of Home

Current tax rules that apply when you sell your main home differ from tax rules that applied when you sold your main home before May 7, 1997. Usually, your main home is the one in which you live most of the time. It can be a:

• House,
• Houseboat,
• Mobile Home,
• Cooperative apartment, or
• Condominium.

See Publication 523 for more information.

Rules for Sales in 2002

You generally can exclude up to $250,000 of gain ($500,000 if married filing a joint return) realized on the sale or exchange of a main home in 2002. The exclusion is allowed each time you sell or exchange a main home, but generally not more than once every two years. To be eligible, during the 5-year period ending on the date of the sale, you must have owned the home for at least 2 years, and lived in the home as your main home for at least 2 years.

Note.   The maximum amount of gain that you can exclude will be reduced if you do not meet the ownership and use tests due to a move to a new permanent duty station.

For married individuals filing jointly who do not qualify for the $500,000 exclusion for gain on a sale of a home because they do not satisfy the ownership and use tests, the limit on the amount of excludable gain should be calculated separately for each spouse. In that case, the maximum exclusion for the couple is equal to the sum of the exclusions to which the spouses would otherwise be entitled if they had not been married.

Property used for rental or business.   You may be able to exclude your gain from the sale of a home that you have used as a rental property or for business. However, you must meet the ownership and use tests discussed in Publication 523.

For more information on the laws affecting the sale of a home in 2002, see Publication 523.

Loss.   You cannot deduct a loss from the sale of your main home.

Rules for Sales Before May 7, 1997

The rules in this section apply to you only if you sold your main home at a gain before May 7, 1997, and all three of the following statements are true.

1. You postponed the gain as described later.
2. The 2-year period you had to replace that home (your replacement period) was suspended while you either:
   1. Served in the Armed Forces, or
   2. Lived and worked outside the United States.
3. You have not already reported to the IRS either your purchase of a new home within your replacement period or a taxable gain resulting from the end of your replacement period, as described under What To Report Now, later.

Gain.   If you had a gain from the sale, you had to include it in your income for the year of sale, except for any part you postponed or excluded.

Loss.   If you had a loss from the sale, you could not deduct it.

Form 2119.   Generally, sales covered by this section were reported using Form 2119. If the rules in this section apply to you, you may have to file a second Form 2119. See What To Report Now, later.

Rules That Provided for Postponing Gain

Under the rules of this section, you were required to postpone tax on the gain on the sale of your main home before May 7, 1997, if both of the following were true.

1. You bought and lived in a new main home before the end of the replacement period.
2. The new main home cost at least as much as the adjusted sales price of the old home.

Also, if you were age 55 or older on the date of sale and met certain other qualifications, no tax applied to any gain you chose to exclude (on line 14 of Form 2119).

This section explains the time allowed for replacing your main home (the replacement period) and how to determine the taxable gain, if any. The main topics in this section are:

• Replacement period,
• Old home,
• New home, and
• Certain sales by married persons.

Tax postponed, not forgiven.   The tax on the gain is postponed, not forgiven. You subtract any gain that is not taxed in the year you sell your old home from the cost of your new home. This gives you a lower basis in the new home.

Example.   You sold your home in February 1997 for $90,000 and had a $5,000 gain. You were a member of the armed forces stationed outside the United States until your return in 2002. In January 2002, within the time allowed for replacement, you bought another home for $203,000 and moved into it. The $5,000 gain was not taxed in 1997, but you must subtract it from the $203,000. This makes the basis of your new home $198,000. If you later sell the new home for $210,000, your gain will be $12,000 ($210,000 - $198,000).

Source of funds to buy home.   You do not have to use the same funds received from the sale of your old home to buy or build your new home. For example, you can use less cash than you received by increasing the amount of your mortgage loan and still postpone the tax on your gain.

Replacement Period

Your replacement period is the time period during which you must replace your old home to postpone any of the gain from its sale. It starts 2 years before and ends 2 years after the date of sale unless the replacement period was suspended.

Example.   You sold your old home on April 27, 1997. You had until April 27, 1999, to buy and move into a new home that you use as your main home, unless you qualified for a suspension of the replacement period.

Suspension of replacement period.   The 2-year replacement period after the sale may be suspended only for members of the Armed Forces stationed outside the United States.

If you are one of these individuals and sold a home before May 7, 1997, your replacement period may include all or part of 2002. For everyone else who sold a home before May 7, 1997, the replacement period ended before 2002.

The replacement period for Members of the Armed Forces stationed outside the United States is up to 8 years after the date of sale (but not later than April 30, 2005).

Serving on extended active duty.   The replacement period after the sale of your old home is suspended while you serve on extended active duty in the Armed Forces. You are on extended active duty if you are serving under a call or order for more than 90 days or for an indefinite period. The suspension applies only if your service begins before the end of the 2-year replacement period. The replacement period, plus any period of suspension, is limited to 4 years after the date you sold your old home, unless you are stationed outside the United States.

Stationed outside the United States.   The suspension of the replacement period after the sale of your old home is extended for up to an additional 4 years while you are:

• Stationed outside the United States, or
• Required to live in on-base quarters following your return from a tour of duty outside the United States. In this case, you must be stationed at a remote site where the Secretary of Defense has determined that adequate off-base housing is not available.

The suspension can continue for up to 1 year after the last day you are stationed outside the United States or the last day you are required to live in government quarters on base. However, the replacement period, plus any period of suspension, is limited to 8 years after the date of sale of your old home.

Example 1.   You are a regular member of the Armed Forces and sold your home on May 1, 1997. During the 4 years from April 1, 1997, to April 1, 2001, you served outside the United States. When you returned, you were stationed at a remote site and were required to live on base because off-base housing was not available. The time to replace your home was suspended:

1. While you were serving outside the United States, plus
2. While you were required to live on base after your return from the overseas assignment, plus
3. Up to 1 year.

The requirement that you live on base ended on October 31, 2001, so the suspension period expired October 31, 2002. You still have the full 2-year replacement period to buy or build and occupy a new home. This is because you did not use any of that time before your overseas assignment began, and your replacement period plus your 5½-year period of suspension is not more than 8 years. Your replacement period ends on October 31, 2004.

Example 2.   The facts are the same as in Example 1 except the requirement that you live on base ended on October 31, 2002. The suspension period will expire October 31, 2003. You have less than the full 2-year replacement period to buy or build and occupy a new home. This is because your replacement period plus your 6½-year period of suspension is limited to 8 years after the sale of your old home. Therefore, your replacement period ends on April 1, 2005.

Spouse in Armed Forces.   If your spouse is in the Armed Forces and you are not, the suspension also applies to you if you owned the old home. Both of you must have used the old home and must use the new home as your main home. However, if you are divorced or separated while the replacement period is suspended, the suspension ends for you on the date of the divorce or separation.

Combat zone service.   The running of the replacement period (including any suspension) is suspended for any period you served in a combat zone. See Combat Zone Exclusion, earlier, for the definition of a combat zone and when service is considered to have been performed in a combat zone.

When suspension ends.   This suspension ends 180 days after the later of:

• The last day you were in the combat zone (or, if earlier, the last day the area qualified as a combat zone), or
• The last day of any continuous hospitalization (limited to 5 years if hospitalized in the United States) for an injury received while serving in the combat zone.

Example.   Sergeant James Smith, on extended active duty in an Army unit stationed in Virginia, had a gain from the sale of his home on April 4, 1997. He had not yet purchased a new home when he entered a combat zone on January 4, 1998. He left the combat zone on January 4, 1999, and returned with his unit to Virginia. He remains on active duty in Virginia.

Sergeant Smith's replacement period began on April 4, 1997, the date he sold the home. If he had not been sent to a combat zone, his replacement period would have ended 4 years later, on April 4, 2001.

When he entered the combat zone on January 4, 1998, Sergeant Smith had used 9 months of the replacement period. The replacement period was then suspended for the time he served in the combat zone plus 180 days. The replacement period started again on July 4, 1999, after the end of the 180-day period (January 5, 1999, to July 3, 1999) following his last day in the combat zone. Sergeant Smith then has 39 months remaining in his replacement period (4 years or 48 months minus the 9 months already used). His replacement period ends October 3, 2002 (39 months after July 3, 1999).

Spouse.   The suspension for service in a combat zone generally applies to your spouse (even if you file separate returns). However, any suspension because of your hospitalization within the United States does not apply to your spouse. Also, the suspension for your spouse does not apply for any tax year beginning more than 2 years after the last day the area qualified as a combat zone.

Home not replaced within replacement period.   If you do not replace the home in time and you had postponed gain in the year of sale, you must file an amended return for the year of sale. You must include in your income the entire gain on the sale of your old home. For details, see What To Report Now, later.

Occupancy test.   You must physically live in the new home as your main home within the replacement period. If you move furniture or other personal belongings into the new home but do not actually live in it, you have not met the occupancy test.

No added time is allowed.   To postpone gain on the sale of your home, you must replace the old home and occupy the new home within the specified period. You are not allowed any additional time, even if conditions beyond your control keep you from doing it. For example, destruction of the new home while it was being built would not extend the replacement period.

Old Home

To figure the taxable gain and postponed gain from the sale of your old home, compare the adjusted sales price of your old home with the cost of your new home, as shown in the following chart.

IF the cost of your new home is...	THEN you...
Equal to or more than the adjusted sales price of your old home	Must postpone your entire gain. None of it is taxed in the year of sale.
Less than the adjusted sales price of your old home	Are taxed on the smaller of: The entire gain (minus any one-time exclusion), or The difference between the adjusted sales price of the old home and the cost of the new home. You must postpone any gain that is not taxed.

Adjusted sales price.   This is the amount realized from the sale of your old home minus:

• Any one-time exclusion you claimed (line 14 of Form 2119), and
• Any fixing-up expenses you had ( line 16 of Form 2119).

If the amount realized (minus any one-time exclusion) is not more than the cost of your new home, you postpone your entire gain. You do not need to figure your fixing-up expenses.

Fixing-up expenses.   Fixing-up expenses are decorating and repair costs that you paid to sell your old home. For example, the costs of painting the home, planting flowers, and replacing broken windows are fixing-up expenses. Fixing-up expenses must meet all the following conditions. The expenses:

• Must be for work done during the 90-day period ending on the day you sign the contract of sale with the buyer,
• Must be paid no later than 30 days after the date of sale,
• Cannot be deductible in arriving at your taxable income,
• Must not be used in figuring the amount realized, and
• Must not be capital expenditures or improvements.

Note.   You subtract fixing-up expenses from the amount realized only in figuring the part of the gain that you postpone. You cannot use them in figuring the actual gain on the sale.

Example.   Your old home had a basis of $55,000. You signed a contract to sell it on December 17, 1996. On January 7, 1997, you sold it for $71,400. Selling expenses were $5,000. During the 90-day period ending December 17, 1996, you had the following work done. You paid for the work within 30 days after the date of sale.

Fixing-up expenses:
Inside and outside painting	$800
Improvements:
New venetian blinds and new water heater	$900

Within the replacement period, you bought and lived in a new home that cost $64,600. You figure the gain postponed and not postponed, and the basis of your new home, as follows:

Gain On Sale
a)	Selling price of old home	$71,400
b)	Minus: Selling expenses	5,000
c)	Amount realized on sale		$66,400
d)	Basis of old home	55,000
e)	Plus: Improvements (blinds and heater)	900
f)	Adjusted basis of old home		55,900
g)	Gain on sale [(c) minus (f)]		10,500
Gain Taxed in Year of Sale
h)	Amount realized on sale	66,400
i)	Minus: Fixing-up expenses (painting)	800
j)	Adjusted sales price		65,600
k)	Minus: Cost of new home		64,600
l)	Excess of adjusted sales price over cost of new home		1,000
m)	Gain taxed in year of sale [lesser of (g) or (l)]		1,000
Gain Postponed
n)	Gain on sale [line (g)]	10,500
o)	Minus: Gain taxed [line (m)]	1,000
p)	Gain postponed		9,500
Adjusted Basis of New Home
q)	Cost of new home [line (k)]	64,600
r)	Minus: Gain postponed [line (p)]	9,500
s)	Adjusted basis of new home		$55,100

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