The Effect of Capital Gain Tax Exclusions on Military Home Sellers
It’s time to sell your home, and you, like most home sellers, hope to walk away with a little extra cash in your pocket. And you probably already know what you’ll do with it. You’ll use it for your down payment on another house, pay off debt, put it toward a kiddo's college fund, or send it straight to investments for retirement.
Before you get ahead of yourself, have you stopped to think about the taxes you might owe on the profit you earn from your home sale? Even though it’s not earned income, the IRS calls the money made in a home sale capital gain and requires you to let them in on the windfall. However, as a military home seller, you may get a tax break if you meet the eligibility requirements.
What is capital gain, and how is it calculated?
- Capital gain is a profit from the sale of property or of an investment.
- Capital gain tax is a tax on the profit made from the sale of property or investment.
- The capital gain tax exclusion is a tax break on the profit made from the sale. Single homeowners can exclude up to $250,000, while married couples filing jointly can exclude up to $500,000.
To help you understand how capital gain taxes are calculated, read the following excerpt from our resource article, What to Know About Taxes When Selling a House.
The amount of tax owed is determined by how long the property was owned before selling. Every year, the IRS determines separate capital gain tax rates for long and short-term asset ownership.
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- Short term capital gain for property, owned less than one year: the tax is based on your income tax rate or your tax bracket.
- Long-term capital gain tax for property owned more than one year is 0%, 15%, or 20%, depending on your taxable income and filing status. Long-term capital gain rates are typically lower than short-term capital gain tax rates.
Single Filers’ Income
- 0% - $0 to $41,675
- 15% - $41,676 to $459,750
- 20% - $459,751 or more
Married Filing Jointly Income
- 0% - $0 to $83,350
- 15% - $83,351 to $517,200
- 20% - $517,201 or more
Married Filing Separately Income
- 0% - $0 to $41,675
- 15% - 41,676 to $258,600
- 20% - $258,601 or more
Head of Household
- 0% - $0 to $55,800
- 15% - $55,801 to $488,500
- 20% $488,501 or more
The IRS has further details for those filing in different categories such as head of household and married filing separately.
Learn the eligibility requirements for tax exclusions.
Ownership: You must have owned the home for the last two out of five years before the closing date of the home sale. If you’re married and filing jointly, only one of you has to meet this requirement.
For more detailed information about eligibility of exclusion requirements, review IRS Form 523
Residence: You owned the home and used it as your primary residence for the last two out of five years prior to the home sale—both spouses must meet this requirement if you’re filing jointly.
The IRS also says:
If you were ever away from home, you should determine whether that time counts towards your residence requirement. A vacation or other short absence counts toward the time you lived at home (even if you rented out your house while you were gone). This departure may make you wonder if your two deployments or PCS move last year disqualifies you from a tax exclusion—but we’ll get to that in just a minute.
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Look-back: You’re only eligible to take the exclusion once in a two-year period. To meet the look-back requirement, neither you nor your spouse can have claimed the exclusion on a prior home sale within the past two years.
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How does a PCS move or deployment affect a capital gain tax exclusion?
Understand what the IRS says about “qualified extended duty” exemption.
Thankfully, the IRS created the "on extended duty exemption" for service members. They allow you to suspend the five-year test period for ownership and residence when you’re on "qualified extended duty."
This means, even if you don’t meet the residency requirement above because you moved last year or served on an overseas deployment for eight months, you can still qualify for a capital gain tax exclusion.
The exemption requirements are as follows:
- You were called or ordered to active duty for an indefinite period, or a definite period of more than 90 days.
- You were serving at a duty station at least 50 miles from your main home, or you were living in government quarters under government orders.
- You are one of the following:
- A member of the armed forces (Army, Navy, Air Force, Marine Corps, Coast Guard).
- A member of the commissioned corps of the National Oceanic and Atmospheric Administration (NOAA) or the Public Health Service.
- A Foreign Service chief of mission, ambassador-at-large, or officer.
- A member of the Senior Foreign Service or the Foreign Service personnel.
- An employee, enrolled volunteer, or enrolled volunteer leader of the Peace Corps serving outside the United States.
- An employee of the intelligence community.
All that said, the period of suspension can’t be longer than ten years. Together, the ten-year suspension and five-year test period can be as long as 15 years, making it easier for you to meet the eligibility requirements for the capital gain tax exclusions.
Note: you can’t suspend the 5-year period for more than one property at a time
If you don’t qualify for a full exclusion even with the exemption, you could still be eligible for a partial exclusion, which is also on Form 523.
3 Tax Implications for Homeowners Selling Rental Property
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You may be in the position to buy a home with the intention to convert the property into a rental property after a PCS.
Many military members choose this investment path to bolster retirement income or simply enjoy an extra chunk of money deposited into their account the first of every month. Remember, just like the sale of a primary residence; there are taxes due in a rental property sale.
Here are three tax situations to consider post-sale.
The IRS offers tax breaks on the depreciation of the home (the structure loses value due to use), a benefit for property owners. However, after the sale, the IRS requires the depreciation benefit returned, otherwise known as depreciation recapture. In other words, if the home sells for more than the depreciated value, you’ll have to pay the taxes you avoided because of depreciation.
Rental Property Conversion or a 1031 Exchange
If you’re anticipating hefty tax payments on the sale of your rental, you’ll want to review your financial choices with a professional. They’ll discuss options such as reverting the rental property back into your primary residence or selling the rental home and reinvesting the money into a like-kind asset, known as a 1031 Exchange. Ask your tax professional for clear answers when discussing your best outcome—depreciation recapture, a rental conversion, and a 1031 Exchange all have their own rules of eligibility and requirements.
In the Future, Consider the Effects of Tax Exclusions Before You Buy
Military home sellers are not unique in that they are eligible for tax relief after they sell a home, but you do have a few specific tax exclusions you should use to your benefit. Keep in mind that, although it may seem like overkill during the home buying process, it is a financially savvy time to prepare an exit strategy for when the need arises to sell your property.
Start the conversation with your real estate agent. This will frame the types of properties and the price points you’ll search together. The numbers should all add up to your selling goals in years to come. Your agent will also likely have a trusted real estate attorney and tax professional they will be happy to recommend to ensure future transactions are smooth.
Please note: this post is not meant to serve as legal advice, but for informational purposes only. For more information about capital gain and what taxes you may or may not be required to pay, you should connect with a tax professional. They can pay special attention to your personal finances and make sure you’re compliant with the IRS.
Looking for another way to save on your home sale? Download MilitaryByOwner’s free ebook, For Sale By Owner: Is It an Option For You?