Can military folks get a break on capital gains if they have to sell a house before they've owned it for two years?
Well, that depends.
I often get asked whether there's a special rule that military members can still use the capital gains exemption if they get permanent change-of-station (PCS) orders before they have lived in their house for two years. The way the question gets asked, the answer is usually no. But that's not the whole story.
No special rule exempts military members from the two-year residency requirement to get the full capital gains exemption. However, rules do permit a partial capital gains exclusion if you don't live in the house for two years -- and they apply to everyone.
Eligibility for a Partial Exclusion
A taxpayer may be eligible for a partial exclusion for four sets of reasons:
- A work-related move that adds 50 miles to your travel distance.
- A health-related move for a health condition for someone in your family.
- Unforeseeable events, such as divorce, pregnancy with multiple babies, unemployment or death.
- Other reasons as determined by the IRS.
Military members become eligible for a partial exclusion because of the 50-mile travel distance. A move is eligible as work-related if you accept a new job that is at least 50 miles farther from your home than your previous job or if your employer transfers you to a new location that is at least 50 miles farther from your home than your previous job. PCSes frequently fit that second criteria.
How a Partial Exclusion Works
If you are eligible for a partial exclusion for one of the reasons listed above, you (or your tax professional) will need to calculate how much exclusion you can take.
This is calculated by turning your qualified occupancy into a fraction of the full two years required for the full exclusion. Technically, this is done daily, and two full years is 730 days. So if you lived in the house for one year (365 days), turn that into a fraction 365/730. If you reduce that, you get one-half.
Then you would take the total exclusion for which you are eligible ($250,000 if single, $500,000 if married) and multiply it by the fraction. In this case, a married couple would be eligible for half of $500,000, or $250,000.
However, look out for a few issues. The calculation is different if two spouses did not live in the house for the same time, and it is also different if you've taken a capital gains exclusion on another property within the last two years. And most people don't live in their properties for exactly 365 days, so your fraction would be different.
Pro Tip: Days training or deployed count as occupied days.
Getting Professional Help
Sometimes, it is good to bring in a tax professional. If you are taking a partial capital gains exemption and aren't confident in how to apply it, this might be exactly the right time to get some help. Enrolled agents and tax accountants should be able to handle this pretty easily.
You may also find more information in IRS Publication 523, Selling Your Home. Be sure you are using the link to get the most recent updates to the law, because these things change from time to time.
While being military may not give you an exception to the capital gains rules, the move ordered by the military may fall under the rules available to all taxpayers. This can save you money on capital gains taxes if you don't get to live in your house for two whole years.
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