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Military Tax Break: Sale of Primary Residence

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Let’s face it. If you are in the military and have purchased a house, often times the real estate market and your PCS orders don’t always agree with each other. Sometimes you’re forced to move when it just doesn’t make sense to sell. Many of you (and myself in the past) elected to rent out your home instead of selling it. When it comes time to sell that house, the IRS is willing to help you out a bit if, as always with the IRS, you meet certain constraints.

For most Americans, if they have lived in their primary residence for 2 of the last 5 years, they can exclude from their taxable income the gains from the sale up to $250,000 for an individual and $500,000 for a married couple filing jointly. Since the IRS (really the Congress) recognizes that military members often don’t have the luxury of picking when they will move or waiting until the value of a home increases the rules are slightly different for military members.

Specifically, the rules allow you to “suspend” the years while you are away from your primary residence while on Qualified Official Extended Duty. Qualified Extended Duty includes a PCS move of at least 50 miles from your current primary residence or if you are assigned to Government Quarters under Government Orders (i.e. you are required to move into base housing due based on your job or some other military requirement).

The suspension can’t be for more than 10 years and you can only do it for one home at a time…you can’t have two primary residences. To simplify all the above, if you lived in your home for at least 2 of the last 10 years and you left your home because of military orders (PCS or into Government Housing) you qualify for the exemption of the Capital Gains on the sale of you primary residence.

But, you’re not done yet. If you turned the house into a rental property while you were gone there are other tax implications. When you rent out a home you can depreciate the value of the structure (land cannot be depreciated) over 27 1/2 years. That depreciation will most likely reduce your tax burden while the house is a rental.  But, if you sell your house for more than the value after the depreciation, the IRS wants their money back.  Think of it this way, when you depreciated your rental, you were telling the IRS that the value of the house was going down.  If in fact it didn’t go down as much as you predicted then you took too much depreciation.  Or to demonstrate with numbers, if you put a house with a value of $100,000 up for rent and you depreciated the value down to $80,000 and then sold the house of $90,000 the IRS will want you to pay taxes on $10,000 of depreciation recapture.  This income is not excluded regardless of whether you meet the 2 of 5 OR 2 of 10 rule since it is not captial gains.  It isn’t taxed as ordinary income either, but the exact tax treatment is a little beyond the scope of this article.  If you sold the same home above for $150,000 you would be subject to depreciation recapture on $20,000 and the $50,000 Capital Gain would be excluded from your income.

Now…I know some of you are thinking you just won’t depreciate your house and you won’t have to worry about this.  Good idea.  But, it won’t work.  Technically, the IRS says depreciation recapture will be assessed based on depreciation taken or depreciation that should have been taken. Failing to take the depreciation will not relieve you from the depreciation recapture.

Military life is tough.  And in my 27 years or so in uniform, I found that moving and selling houses was one of the most stressful times.  The Congress wants to help you out with the financial stresses of selling a house or being forced to turn it into a rental.  If you are aware of the rules you can significantly control your tax burden from selling a home.

Curt Sheldon is a Fee-Only Financial Planner based in Northern Virginia.  He can be contacted at (703)542-4000 or Curt@CLSheldon.com

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication