Do Disabled Veterans Pay Capital Gains Tax on Property Sales?

Selling a property can trigger capital gains tax, calculated on the profit made from the sale. For disabled veterans, exemptions or relief programs may reduce or eliminate this tax burden, depending on their service-connected disability status. Understanding these rules ensures eligible veterans take full advantage of available benefits.

How Capital Gains Tax Generally Applies

When a property is sold for more than its purchase price, the profit is considered a capital gain and may be taxed. The IRS categorizes these gains as short-term or long-term based on how long the property was owned. If held for one year or less, the gain is taxed at the seller’s ordinary income tax rate, which can be as high as 37% in 2024. If owned for more than a year, it qualifies for long-term capital gains tax rates, ranging from 0% to 20%, depending on taxable income.

Homeowners may qualify for a primary residence exclusion under Section 121 of the Internal Revenue Code, allowing individuals to exclude up to $250,000 of capital gains ($500,000 for married couples filing jointly) if they have lived in the home for at least two of the last five years before selling. This exclusion does not apply to investment or rental properties, which are subject to capital gains taxation unless tax strategies like a 1031 exchange are used.

Special Exemptions for Service-Connected Disability

Veterans with service-connected disabilities may qualify for exemptions that reduce or eliminate capital gains tax liability. While the IRS does not offer a specific exemption for disabled veterans, certain tax benefits provide indirect relief. One key advantage is that VA disability compensation is tax-free and does not count as taxable income, potentially placing veterans in a lower capital gains tax bracket.

State-level property tax exemptions can also impact a veteran’s tax burden. Some states extend benefits beyond annual property tax reductions to include relief on capital gains tax when selling a primary residence. For example, California’s Disabled Veterans’ Exemption reduces property taxes, helping ease the financial impact of homeownership and selling costs. Veterans should check with their state tax authority to determine if similar benefits apply.

If a veteran sells a home due to a change in health or disability status, certain expenses may be deductible. Home modifications for medical reasons or moving expenses related to a disability could qualify as deductions under IRS rules. IRS Publication 502 outlines medical expense deductions that may apply if a veteran had to sell a home due to accessibility needs.

Additional Relief for Property Sales

Disabled veterans may access specialized relief programs designed to ease financial burdens when selling property. VA grants, such as the Specially Adapted Housing (SAH) or Special Housing Adaptation (SHA) programs, help fund home modifications for accessibility. These improvements can increase the property’s cost basis, reducing taxable gains when the home is sold.

Timing the sale strategically can also provide tax advantages. If a veteran expects a drop in taxable income due to retirement or reduced earnings, postponing the sale to a lower-income year could result in a reduced capital gains tax rate. In 2024, long-term capital gains tax rates range from 0% to 20%, and veterans with lower annual income may qualify for the 0% bracket, eliminating tax liability on the sale.

Estate planning strategies can further minimize capital gains tax. If a veteran plans to pass the property to heirs, a step-up in basis can significantly reduce tax liability. When a property is inherited, its cost basis is adjusted to the fair market value at the time of the original owner’s death. If the heirs sell the property soon after inheriting it, they may owe little to no capital gains tax. Establishing a living trust or other estate planning tools with a tax professional can help maximize these benefits.

Filing Requirements and Documentation

Reporting a property sale on a tax return requires accurate documentation to comply with IRS regulations. IRS Form 8949 details the proceeds, cost basis, and any applicable adjustments to determine taxable gain. This information is summarized on Schedule D of Form 1040, where capital gains or losses are reported. Veterans should ensure all figures align with Form 1099-S, issued by the settlement agent or closing attorney. Discrepancies between these documents can trigger IRS scrutiny.

Supporting records are essential for substantiating deductions or exclusions. Settlement statements, purchase agreements, and receipts for capital improvements should be retained to calculate the adjusted cost basis. Veterans qualifying for tax benefits due to disability status should keep documentation from the VA confirming their eligibility. Records related to home modifications, medical necessity, or grants received should also be organized to support potential deductions.

Potential State-Level Considerations

State tax policies can significantly impact the tax burden for disabled veterans selling property. Some states fully conform to IRS rules, while others impose their own capital gains taxes with different rates and exemptions.

States such as Texas and Florida do not levy a state capital gains tax, benefiting veterans selling property in those locations. Others, including California and New York, tax capital gains as regular income, meaning high earners could face substantial state tax liabilities. Some states offer property tax exemptions for disabled veterans that indirectly affect capital gains by reducing the overall financial burden of homeownership. A few jurisdictions provide direct capital gains tax exemptions or reductions for veterans who meet specific residency and disability criteria. Checking with a state tax agency or consulting a tax professional can help veterans determine what benefits apply in their specific situation.