Can Military Members Avoid Capital Gains Tax When Selling a House?

Selling a home can have significant tax implications, particularly for military members who frequently relocate. Understanding available tax benefits can help service members avoid unnecessary financial burdens.

Certain provisions in the tax code allow military personnel to reduce or eliminate capital gains taxes when selling a primary residence. These rules acknowledge the unique challenges of military life and provide exemptions not available to civilians.

Capital Gains Exclusions

The IRS allows homeowners to exclude up to $250,000 in capital gains from the sale of a primary residence, or $500,000 for married couples filing jointly. To qualify, the homeowner must meet the ownership and use tests, which generally require living in the home for at least two of the last five years before selling.

Frequent relocations can make meeting these requirements difficult. However, the Servicemembers Civil Relief Act (SCRA) and the Military Family Tax Relief Act let service members suspend the five-year residency requirement for up to ten years if they are stationed elsewhere due to military orders. This means military homeowners may still qualify for the exclusion even if they have not lived in the home for several years.

Extended Ownership Provisions

Military personnel often hold onto homes longer than planned due to deployments or reassignments. The tax code accounts for these situations by allowing service members to extend the standard ownership timeline for capital gains exclusions.

This provision helps maintain eligibility for tax benefits even if time in the home was interrupted. Service members can also rent out their property without immediately losing eligibility for the exclusion. While rental income remains taxable, converting a primary residence into a rental without forfeiting future capital gains exclusions can be financially beneficial, particularly in high-cost housing markets.

Determining Your Residency

Residency status affects tax obligations when selling a home. Unlike civilians, who establish residency based on where they live and work, service members often maintain legal residency in a state despite being stationed elsewhere. This distinction can impact eligibility for tax benefits, especially in states without income tax or those offering military-specific exemptions.

Under the SCRA, military members can retain their legal domicile despite frequent relocations. Some states extend this protection to spouses through the Military Spouses Residency Relief Act (MSRRA), allowing them to maintain the same residency as the service member. This can be advantageous when selling a home, as certain states provide property tax exclusions or reduced capital gains taxes for residents.

For those who rented out their home before selling, depreciation recapture must be considered. The IRS requires homeowners to pay taxes on any depreciation claimed while the home was a rental. Some states offer exemptions or reduced tax rates for military personnel, making it important to review state-specific rules when calculating tax liabilities.

Reporting Your Gains

Military members must accurately report any taxable capital gains to the IRS. If the sale qualifies for an exclusion under Section 121 of the Internal Revenue Code, the gain may not need to be reported. If the profit exceeds the exclusion limits or the home was used for non-qualifying purposes, the excess amount must be documented on Schedule D (Form 1040) and Form 8949. Keeping records of the purchase price, improvements, and sale proceeds is essential in case of an IRS audit.

For homes that were rented or used for business, depreciation recapture applies under Section 1250 of the tax code. Any depreciation claimed must be reported as ordinary income and taxed at a maximum rate of 25%. This can significantly impact tax liability, particularly if the property was a rental for an extended period. Maintaining detailed records of depreciation expenses and improvements helps accurately calculate the adjusted cost basis, which directly affects taxable gains.

State Tax Variations

While federal tax laws provide relief for military members selling a home, state tax laws vary and can affect the financial outcome of the sale. Some states fully conform to federal capital gains exclusions, while others impose additional requirements or offer unique exemptions for service members.

States like Florida, Texas, and Nevada do not impose state income tax, meaning capital gains from a home sale are not taxed at the state level. In contrast, states such as California and New York impose high capital gains tax rates and may have additional rules regarding depreciation recapture or residency requirements. Some states extend the period to claim the capital gains exclusion or waive certain tax obligations if the sale is due to a permanent change of station (PCS).

Military homeowners should also be aware of state-specific filing requirements. Some states require separate reporting of capital gains, even if no tax is owed, while others may require documentation proving military status to qualify for exemptions. Consulting a tax professional familiar with both federal and state tax laws can help ensure compliance and maximize available benefits.