The United States Government want you to own your home. There are a lot of tax advantages to home ownership, such as the ability to deduct mortgage interest (as long as the mortgage is for home acquisition or improvement). In my mind though, the biggest benefit is the ability to exclude, under certain circumstances, gains on the sale of your primary residence from your taxable income. That is s a pretty good deal and could literally save you tens of thousands of dollars in taxes. But as mentioned, you have to meet certain criteria.
The Hoops You Have to Jump Through to Take the Exclusion
A single taxpayer can exclude up to $250,000 in gains on the sale of a primary residence and a married couple filing jointly can exclude up to $500,000 in gains.
To get the $250,000 exclusion, you must meet two criteria
- You must have used and owned the home as a principal residence for at least two years during the five-year period prior to the sale
- You must not have excluded any gain on another home during the two-year period prior to the sale
The ownership and use test do not have to be concurrent.
To qualify for the $500,000 exclusion, both of the married couple must have used the house for 2 years. The use does not have to be concurrent and only one spouse needs to meet the ownership test. If both spouses do not meet the use test, then the exclusion is limited to $250,000.
Under certain circumstances a reduced exclusion may be allowed if the use or ownership tests are not met.
Special Tax Treatment for Military Members
Congress realized that military members move a lot and selling the house may not be advisable , so they wrote an exception to the rules above. The law allows the military member/family to suspend the five-year time test for up to 10 years, if the military member is on qualified official extended duty. Qualified official extended duty is either:
- A new duty station at least 50 miles from the current main home. While the tax code doesn't use the words PCS, that is my interpretation
- The military member is required by government orders to move into government quarters. An example would be selection for command and a requirement to move on base (or post).
Under these rules, your 5-year test could become a 15-year test. Here is an example:
- You own and live in the house for 2 years.
- You move out of the house pursuant to PCS orders. The clock stops.
- 10 years pass, the suspension ends. You now have owned the house for 12 years.
- 3 years pass and you sell the house. You've owned the house for 15 years, but for purposes of the use test you have lived in it for 2 of the last 5 years.
The Tax Code is silent on what happens when the military member retires. The conservative approach would be to assume that the clock starts again when you retire and you're no longer constrained by your military service. But, again the Code is silent on this issue.
Military Taxes are Different
I can count 40 different places in the Tax Code where active duty military members and/or veterans are treated differently by the tax code than civilians. Kind of makes you think you should work with a financial and tax advisor that knows the differences.