Military Capital Gains Exemption If Selling in Under 2 Years

Selling a home within two years of ownership typically triggers capital gains taxes, but military personnel may qualify for exemptions or reductions due to service-related relocations. These tax benefits help ease the financial burden of frequent moves.

Understanding these exemptions can prevent unexpected tax liabilities and maximize savings.

Minimum Ownership Period

To qualify for the full capital gains tax exclusion under IRS rules, homeowners must generally own and use a property as their primary residence for at least two of the five years before selling. This allows single filers to exclude up to $250,000 in gains and married couples filing jointly to exclude up to $500,000.

Selling before the two-year mark can result in taxable gains beyond these limits. However, the IRS permits partial exclusions for certain circumstances, including job relocations, health issues, or other qualifying hardships. Military personnel benefit from additional tax relief when a move is required due to official orders.

Prorated Exclusion for Military Relocations

Service members who must relocate due to official orders may qualify for a prorated capital gains exclusion, even if they haven’t met the two-year residency requirement. This provision accounts for the frequent moves military personnel face and reduces tax liability when selling a home earlier than planned.

The exclusion is based on the portion of the two-year period the home was used as a primary residence. For example, if a service member lived in a home for 12 months before receiving relocation orders, they could exclude 50% of the standard capital gains exclusion. A single filer could exclude up to $125,000, while a married couple filing jointly could exclude up to $250,000. The formula used is: (Months of qualified use ÷ 24) × Full Exclusion Amount.

To qualify, the move must be due to a permanent change of station (PCS), which includes transfers to a new duty station, deployments of at least 90 days, or separation from service requiring relocation. Proper documentation, such as military orders and proof of residence, is necessary when filing taxes.

Cost Basis Adjustments

The cost basis of a home determines the taxable profit from a sale. It includes the purchase price plus certain adjustments.

Eligible home improvements that add value, extend the home’s lifespan, or adapt it for new uses can increase the cost basis and reduce taxable gains. Examples include kitchen remodels, new roofing, or energy-efficient installations. Routine maintenance, such as painting or fixing leaks, does not qualify. Keeping receipts and contracts for these improvements is essential.

Closing costs and fees at the time of purchase, such as title insurance and legal fees, can also be included in the cost basis. However, expenses like prepaid interest and private mortgage insurance (PMI) are not. If the home was inherited, the cost basis is generally adjusted to the fair market value at the time of the previous owner’s death, which can significantly reduce or eliminate taxable gains.

Accounting for Rental Usage

Renting out a home before selling introduces additional tax considerations. The IRS requires depreciation recapture on any depreciation claimed while the property was rented. This recaptured amount is taxed at a maximum rate of 25%, even if the home qualifies for a partial capital gains exclusion due to military relocation.

Rental use also affects the capital gains exclusion. If a home was rented after 2008, the portion of the gain attributed to rental use is considered “nonqualified use” and does not qualify for exclusion. The taxable portion is determined by the ratio of rental time to total ownership. For example, if a home was owned for five years but rented for two, 40% of the gain would be taxable.

Reporting Gains on Tax Returns

Military personnel who qualify for a full or prorated capital gains exclusion may not owe taxes on the sale, but they must still report the transaction correctly. IRS Form 8949 is used to document the sale price, cost basis adjustments, and any depreciation recapture. The totals from this form are then transferred to Schedule D of Form 1040, where capital gains or losses are officially reported.

If the total gain does not exceed the allowable exclusion and the home was never rented, the sale generally does not need to be reported. However, if any portion of the gain is taxable—due to rental use, depreciation recapture, or exceeding the exclusion limit—it must be included in the tax return. Capital gains tax rates are 0%, 15%, or 20%, depending on taxable income.

Military members who sell at a loss cannot deduct the loss unless the property was classified as an investment or rental property. Keeping records of settlement statements, home improvement receipts, and rental history is important in case of an IRS audit.