A "tax fairness" debate is heating up on Capitol Hill in the wake of war rumblings in the Middle East and the IRS's latest rules governing home sales.

To critics of federal policy, the Internal Revnue Code now forces thousands of American home sellers--employees of governmental or private organizations--to pay capital gains taxes on home sale profits needlessly.

Peter K. Scott, a tax attorney who serves as counsel to the Washington-based Employee Relocation Council, says the situation is "extremely unfair and was never intended to exist in the first place."

The situation Scott describes is the treatment of members of the U.S. military services, the State Department's foreign service, and employees of private companies who are transferred overseas or far from their homes for extended periods of time. Because of what Scott calls "an oversight" by Congress in 1997, these transferees now pay millions of dollars in capital gains taxes that virtually all other American home sellers avoid.

Under the 1997 revisions to the tax code, sellers can exclude up to $250,000 (single-filing taxpayers) or $500,000 (married joint-filers) of their home-sale gains, provided they have owned and used the property as their principal residence for two of the five years preceding the sale.

That wording erects costly hurdles for members of the armed forces, foreign services and private employees who are transferred overseas for multi-year assignments. When they return to the houses they've owned--but not occupied--for long periods, they find they cannot pass the two-of-five-year test and are subject to capital gains taxes.

Say you're sent overseas by your company on multiple assignments for a total of five years, and you rent out your house during your absence. When you return and want to sell, you face capital gains taxes on all your profits--even those accumulated long before your overseas transfer.

If you had to sell the property immediately on your return and had racked up a $300,000 gain over the total period of ownership, for example, you'd pay federal capital gains taxes at 20 percent on all $300,000. In regulations issued at the close of 2002, the IRS declined to make a special exception for employees like this, noting that it lacked statutory authorization. The vast majority of U.S. homesellers, by contrast, are not touched by the overseas transfer rules and normally pay little or no capital gains taxes on their sales.

Peter Scott says well over 100,000 corporate employees are living abroad in a typical year, under requirements by their employers. Unknown numbers of military and foreign service personnel are in the identical position, he says--a particularly unfair situation given the extra physical sacrifices many of them make at the demand of their government.

The estimated total extra tax dollars collcted by the IRS for all such employees--civilian and government-employed--exceeds $400 million over 10 years, according to Scott. Legislation was nearly passed last session eliminating the problem for military and foreign service personnel, but private corporate transferees were excluded from the bills.

"There is no evidence in the record anywhere that Congress ever intended to single out these people" for special tax punishement, says Scott. "They are all people who are away from their homes because their employers require them to be elsewhere" as a condition of employment. It is totally unfair that they should be forced "to pay taxes when their fellow (homeowners) pay none," he said.

Capitol Hill sources told Realty Times last week that the odds are good--especially given the war clouds on the horizon--that last year's "Armed Forces Tax Fairness Act" (HR 5557), which faltered in the lame-duck session in November--will be revived in the new session.

What about corporate relocatees? There's much less hope for short-term relief for them, according to the sources.