Constructive receipt of income "earned" on the last day of the year

[Mr. Green]

We expect to close of the sale of a house on December 31st. The sale will generate about $30,000 of capital gains. I've been trying to figure out if we'd consider this income in 2019 or 2020 and I'm still confused. If we close, it will mean all the funds have been received from the buyer into the closing attorney's escrow account. I'd sign the deed and it should be recorded electronically with the county that afternoon. The attorney's paperwork states that they won't cut a check for the seller until the deed is recorded, so that makes it seem like it's possible the check might not be generated until January 2nd. Investopedia says this about the IRS rule on constructive receipt.

"An individual is considered to be in constructive receipt of income when they have the ability to control or utilize the funds, even if they do not have direct possession of them, or if it is guaranteed they will have the ability to draw upon the funds in the future."

To me that reads like I would have constructive receipt of the funds on the 31st. However the closing attorney advised me to check with my CPA because a closing on the 31st doesn't necessarily mean the income would be taxed in 2019. Based on how the closing process works, I don't understand his position since the funds would already be received if they record a deed the same day.

Can anyone here set me straight?

[Mr. Green]

Additional info, but I'm still not certain....

This is right from the IRS's website.

"Constructive receipt. You have constructive receipt of income when an amount is credited to your account or made available to you without restriction. You do not need to have possession of it. If you authorize someone to be your agent and receive income for you, you are treated as having received it when your agent received it."

Using a closing attorney for a real estate sale is essentially authorizing someone to be my agent to receive income for me. That's one of the main reasons people use closing attorneys, to ensure the receipt of funds before the deed is signed over. Multiple people are paid out of the funds, the bank who has a mortgage on the asset being sold, the real estate agent, and the seller, etc. But to me, that reads like I would have constructive receipt of the money. There are no circumstances under which the attorney can choose not to pay me so I basically have a guarantee of receiving that money, and the attorney is acting on my behalf in receiving and disbursing the funds to me.

But I'm not a professional, so I'm not absolutely confident that I'm right.

[terran]

Here's the actual law regarding constructive receipt: https://www.law.cornell.edu/cfr/text/26/1.451-2

Since this money isn't available to you in 2019, it seems like you won't have constructive receipt. The only concern I would have is whether an escrow account changes things at all. Does money in an escrow account somehow "belong" to the person it's intended for?

I found this, which seems to say "it depends" http://deferthetax.com/media/Are_funds_in_escrow_constructively_received.pdf

[SwordGuy]

You don't have access to or any legal rights to that money until the deed is registered.   "Something" could go wrong on deed registration day, like a lien that popped up out of nowhere.   The attorney could embezzle it and catch a flight to Rio de Janeiro.   The attorney could get run over by a bus and it might not get registered for weeks while stuff gets sorted out.

I would consider it 2020 money unless you have some burning need or advantage to owing the tax for 2019.

But I wouldn't spend the tax money until after you file for 2019 and its accepted, just in case Uncle Sam disagrees.

[Mr. Green]

The challenge is we have large ACA tax subsidies that hang in the balance. If the money hits in 2020 then I need to do Roth conversions and some capital gains harvesting for get our income where I want it. If I don't make these trades and the money from the house sale is delayed, we likely fall into Medicaid level income and would not qualify for the tax credits. If I make the trades and the house sale does complete in 2019 then it pushes our income over the threshold for tax credits and we owe about $10,000 in taxes. It's extremely important that we handle this correctly, or if there's any risk of a mistake we consider pushing closing to the 2nd to be sure we don't execute trades AND receive constructively receive the income from the home sale in 2019. I'm going to drop my the attorney"s office Monday and discuss all this with him.

[Mr. Green]

Spoke with my buyer this afternoon and I'm being told that they wire money the same day we close. This buyer has bought 10 or so houses this year alone so he's basing that on his past transactions. I will confirm this with the closing attorney Monday morning. If they're prepared to do this then that's awesome, but I'm left wondering if I should request a paper check. A paper check in my hand is clearly constructive receipt of the money. It's less clear to me what a wire transfer in progress would be if, say, it was initiated on the 31st but didn't clear my account until the 2nd. I'll be contacting my bank to see if there's a cutoff time for same day clearing of a wire transfer on Monday as well.

[norajean]

Are you sure you can’t find an extra $30k in capital improvement receipts to offset the gain?

[Mr. Green]

Are you sure you can’t find an extra $30k in capital improvement receipts to offset the gain?

Positive. We put almost nothing into the place for the 7 years we owned it and what we did do I've accounted for, including the allowable closing costs when we bought it.

[secondcor521]

It would seem easiest to me to work with your attorney and the closing folks and your bank to take action to make sure you're not in constructive receipt by 12/31.  Make the Roth conversions and realize cap gains on Monday, then don't sign papers until 4:45pm or something on Tuesday so that the deed can't get recorded or the funds can't be wired that day to your attorney.  Another thing you could do is to ask your attorney to avoid interacting with the buyers or the closing folks that afternoon.

Or, if your buyer is amenable and there aren't large fees associated with redrafting the documents, move the closing to 1/1.

Although this does raise the question of when capital gains are realized and Roth conversions are done, since those things can be a two or three day process to complete.

[Paul der Krake]

Spoke with my buyer this afternoon and I'm being told that they wire money the same day we close. This buyer has bought 10 or so houses this year alone so he's basing that on his past transactions. I will confirm this with the closing attorney Monday morning. If they're prepared to do this then that's awesome, but I'm left wondering if I should request a paper check. A paper check in my hand is clearly constructive receipt of the money. It's less clear to me what a wire transfer in progress would be if, say, it was initiated on the 31st but didn't clear my account until the 2nd. I'll be contacting my bank to see if there's a cutoff time for same day clearing of a wire transfer on Monday as well.

One could argue that a check isn't very different than a transfer in progress. The check may not clear for days either! It could be fraudulent! The issuing bank may fail!

Interesting grey area you've got going on. I almost want you to get audited to satisfy my own curiosity.

In practice though, I doubt anyone at the IRS is going to care. You sold a house and signed a million documents on the 31st, call it a day and say you got paid on the 31st if that's what you want.

edit: also, WTF, isn't that exactly the job of a closing attorney to explain wrinkles like this to their clients?

[Mr. Green]

It would seem easiest to me to work with your attorney and the closing folks and your bank to take action to make sure you're not in constructive receipt by 12/31.  Make the Roth conversions and realize cap gains on Monday, then don't sign papers until 4:45pm or something on Tuesday so that the deed can't get recorded or the funds can't be wired that day to your attorney.  Another thing you could do is to ask your attorney to avoid interacting with the buyers or the closing folks that afternoon.

Or, if your buyer is amenable and there aren't large fees associated with redrafting the documents, move the closing to 1/1.

Although this does raise the question of when capital gains are realized and Roth conversions are done, since those things can be a two or three day process to complete.

Somehow the multi-day aspect of Roth conversions failed to occur to me, probably because I've never had to do one with a competing priority at the last minute before. You're probably right that I've waited too long to begin the conversion and ensure it's considered a 2019 transaction, though I can call Vanguard to verify. What a pain in the ass this has become. Note to self, no more big financial transactions of uncertain timing within the last few days of the year. Not when 5-figures in ACA premium tax credits hang in the balance.

[secondcor521]

It would seem easiest to me to work with your attorney and the closing folks and your bank to take action to make sure you're not in constructive receipt by 12/31.  Make the Roth conversions and realize cap gains on Monday, then don't sign papers until 4:45pm or something on Tuesday so that the deed can't get recorded or the funds can't be wired that day to your attorney.  Another thing you could do is to ask your attorney to avoid interacting with the buyers or the closing folks that afternoon.

Or, if your buyer is amenable and there aren't large fees associated with redrafting the documents, move the closing to 1/1.

Although this does raise the question of when capital gains are realized and Roth conversions are done, since those things can be a two or three day process to complete.

Somehow the multi-day aspect of Roth conversions failed to occur to me, probably because I've never had to do one with a competing priority at the last minute before. You're probably right that I've waited too long to begin the conversion and ensure it's considered a 2019 transaction, though I can call Vanguard to verify. What a pain in the ass this has become. Note to self, no more big financial transactions of uncertain timing within the last few days of the year. Not when 5-figures in ACA premium tax credits hang in the balance.

If it helps, I did my last Roth conversion last Tuesday 12/24.  I put in the conversion request on Vanguard's website during the day and the transaction happened at close that day.  The transaction date was 12/24 on both accounts.  Both my IRAs are at Vanguard.

[Mr. Green]

It would seem easiest to me to work with your attorney and the closing folks and your bank to take action to make sure you're not in constructive receipt by 12/31.  Make the Roth conversions and realize cap gains on Monday, then don't sign papers until 4:45pm or something on Tuesday so that the deed can't get recorded or the funds can't be wired that day to your attorney.  Another thing you could do is to ask your attorney to avoid interacting with the buyers or the closing folks that afternoon.

Or, if your buyer is amenable and there aren't large fees associated with redrafting the documents, move the closing to 1/1.

Although this does raise the question of when capital gains are realized and Roth conversions are done, since those things can be a two or three day process to complete.

Somehow the multi-day aspect of Roth conversions failed to occur to me, probably because I've never had to do one with a competing priority at the last minute before. You're probably right that I've waited too long to begin the conversion and ensure it's considered a 2019 transaction, though I can call Vanguard to verify. What a pain in the ass this has become. Note to self, no more big financial transactions of uncertain timing within the last few days of the year. Not when 5-figures in ACA premium tax credits hang in the balance.

If it helps, I did my last Roth conversion last Tuesday 12/24.  I put in the conversion request on Vanguard's website during the day and the transaction happened at close that day.  The transaction date was 12/24 on both accounts.  Both my IRAs are at Vanguard.

This is helpful, thank you!

The problem isn't quite as big a deal and I originally thought it was. It will cost us $2,500 in extra taxes if all the income hits, versus the five figures I thought it would be because we won't go over the ACA subsidy cliff. However, I still don't want to give the tax man an extra $2,500 if I can help it and I believe I have a solution for that. I will go ahead and perform a Roth conversion tomorrow after verifying with Vanguard the transaction date will be tomorrow. This keeps us away from the Medicaid income threshold no matter what. If we end up with a check from the house sale, we will have until April 15th to make traditional IRA contributions with some of that money to offset the Roth conversion and lower our income back down to where I want it. If something gets screwed up and they don't get us a check we will have left about $6,000 of tax free space on the table for the year.

[EricEng]

Sounds like the money won't be with you yet.  I always view escrow as a neutral third party making sure both parties honor the deal.  That's different than hiring a person to receive your money.  It isn't yours until escrow holder agrees the terms are honored and pays it to you.

[Mr. Green]

It all worked out. We closed this morning at 11am and I picked up the check at 5pm. The attorney is also filing a 1099-S on the sale for the 2019 tax year. I'm confident that we'll be just fine showing the income on our 2019 taxes.

[jpdx]

Glad it worked out. That was a nail biter to read!