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What if you don't tell about your home sale?

While the home-sale exclusion amounts, even the partial ones, are pretty generous, in a hot real estate market some people might be able to pocket more than a quarter million or half a million dollars in home-sale profits.

Since the Internal Revenue Service no longer asks sellers to routinely report all residential real estate transactions, how's the tax collector to know how much sellers made if they don't tell? Couldn't Jane and John Q. Public simply pocket a $600,000 profit on their home, leaving their bank account fatter and the IRS none the wiser that it missed out on thousands of tax dollars on that extra $100,000?

The U.S. tax filing system relies on voluntary compliance, so such underreporting is possible. Technically, there is a mechanism to protect against sellers not reporting taxable home-sale profits. Closing agents are supposed to send Form 1099-S, Proceeds From Real Estate Transactions, to the property sellers and copy the IRS. This would let the IRS know there was a real estate transaction, although it would still be up to the seller to determine whether any of the reported sales price is taxable. But not every seller gets this form, which means neither does the IRS.

"There may be no good way that the IRS would know," says Mark Luscombe, lawyer, accountant and principal tax analyst at CCH Inc., a Riverwoods, Ill.-based provider of tax law information and software. "Of course, real estate transactions are public records, so the IRS in theory could get access to information on home sales and the transactions, but whether they in fact have the resources to do that and would do that is of considerable doubt."

And Luscombe has a word of warning for anyone thinking about hiding a nice chunk of home-sale profit from the IRS.

"If a transaction is not disclosed on the return there is really no statute of limitations. So when you talk about a normal three-year statute of limitations period, that would not apply to something that's not disclosed on the return," he says. "So the taxpayer would never really be able to close that out if they did not disclose the transaction."

In essence, such a willful effort to avoid paying Uncle Sam is tax fraud. The IRS can come after such suspected tax cheaters whenever it discovers the attempt, be it three years or 10 years or 50 years later.

So before you try to sneak that taxable profit past the IRS, be sure to ask yourself: Is any amount of tax savings really worth all those years of worrying about whether an auditor might someday give you a call?

Freelance writer Kay Bell writes Bankrate's tax stories from her home in Austin,
Texas, and blogs on tax topics at Don't Mess with Taxes

-- Updated: March 27, 2007

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