Capital Gains Rules for Military Families

Updated: February 14, 2024
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    Why should you get educated about capital gains rules for military families? When you purchase a home, you enter a world of tax rules, write offs, and related concerns that can get more complicated when the owner is a military member or part of a military family.

    And the rules can get more complicated for military members who own rental properties. As we’ll discover below, owning a home and the income you get from renting it out have specific tax implications and while this article is NOT to be considered tax advice, it should act as a motivator to get you talking to a tax professional who can help you make the best choices based on tax law in the current year.

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    Capital Gains For Military Families: The Basics

    The moment you become a home owner you will find that your tax filing needs become quite different. If you want to claim deductions that come with home ownership, you must be able to claim itemized deductions on Schedule A of your Form 1040.

    These deductions include home mortgage interest, mortgage points, and real estate taxes. However, if your standard deduction is greater than the total of your itemized deductions, then you won’t really see much of a tax benefit from home ownership.

    One of the first deductions you learn about as a new home owner is the ability to write off your home loan interest payments. You may also be able to write off your mortgage insurance, real estate taxes, and other payments depending on circumstances and current tax law.

    Remember that tax laws are subject to change year to year and the tax breaks offered today may not be available next year. You will need to consult a tax professional about the current deductions, their limits, and how you must file.

    We mention the tax breaks here because you will need to become literate about many aspects of federal tax law in order to know what your capital gains responsibilities are later down the line.

    When You Sell Your Home

    Buying the home provides you with a variety of tax breaks. Selling your home means you must anticipate paying taxes on the profit from that sale.

    But the rules can be a bit complex. For example, Investopedia reports that in previous tax years, a tax break has been offered to any homeowner, military or not, who lived in the home for at least two of the five years before the sale.

    In these cases, the seller was allowed to exclude $250K for a single filer and $500K for a married couple–that is money exempt from federal taxation if you used your home as the principal residence for two of the five past years. Under the rules governing this set of circumstances, the seller is not permitted to get a capital gains exemption more than once every two years or 24 months.

    There is big potential to misunderstand the nature of this taxation–the tax you pay is on the net profit from the sale, not the total amount.

    To properly calculate your profit, you would need to know your cost, or basis. This includes any closing costs associated with your purchase.

    Once you know your basis, you would increase this amount by the cost of any capital improvements, such as replacing your roof, AC system, or major renovations. Subtract your basis from your proceeds, minus selling expenses, to arrive at your capital gain.

    For example, let’s imagine that you bought a house in 2021 for $300,000. You paid $5,000 in closing costs when you bought the home. You sold the home in 2023 for $800,000, with 6% sales commission.

    While you owned the home, you renovated the kitchen at a cost of $30,000. What is your profit?

    Profit equals:
    Cost ($300,000), plus $5,000 in closing costs = $305,000
    Renovations = $30,000
    Sales price = $800,000, minus $48,000 (6% commission) = $752,000
    Capital gain = $752,000 – $305,000 – $30,000 = $417,000.

    Extra Time For Military Members

    Tax laws in past years state that active duty military members who get Permanent Change of Station Orders that relocate the homeowner more than 50 miles away can pause the “clock” on those capital gains tax rules mentioned above for occupancy.

    Non-military people have to occupy the home for two of the last five years before the sale, but military members can pause that clock no more than 10 extra years–a healthy amount of time to deal with a PCS.

    That basically means that a military seller can get the tax exemption from the first $250k or $500k if married if they lived in the home for two of the last 15 years at the very latest (the amount of the original five year period plus 10 additional years maximum).

    These tax laws, as written in past tax years, do NOT permit you to do this on more than one property at a time. You cannot pause the clock on more than one house.

    Selling A Rental Property

    When you sell a house you purchased and later made into a rental property, there are two potential tax issues to deal with. One is the previously mentioned capital gains tax, but the other is known as recaptured depreciation or uncaptured section 1250 gain.

    Those selling rental units should be prepared to have their capital gains taxes calculated using any profit made on the sale of the rental property and don’t forget that the exemption on the first $250k to $500k (depending on marital status) hinges on having lived in the home two of the last five years before the sale.

    Federal tax law provides for certain restrictions in cases where a home owner moves out of and back into a “previous rental property.”

    The other tax issue is recaptured depreciation, which is concerned with the deductions for depreciation you may have taken when the property was being rented out. Taxes in this area depend on actual use of the deduction. In general you may find that you could be required to pay the IRS as much as 25% of the amount you have depreciated on the property when it served as a rental.

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