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Military members often become homeowners when they decide the investment financially makes sense. Often, major considerations when choosing a home include affordability, long-term commitment to the property, and potential resale value. Others who may have studied local real estate markets could decide it’s a good idea to buy a home with renting in mind.
When a military homeowner considers the question, "Do you pay taxes when you sell a house?" regardless of the reason, whether it’s a short or long-term investment, there will be tax implications. Buying a home without considering potential capital gains tax can be a costly mistake.
When buying a home, service members should choose real estate professionals who not only work on their behalf to find the perfect property and execute a great deal, but also take the time to explain tax implications and estimate the finances involved with a future sale.
Here are some scenarios that can impact taxes when a military homeowner sells their property.
Military Home Sale Tax Benefits
Do military members pay capital gains tax when selling a home?
Yes, service members may be required to pay capital gains taxes when selling a home, but there are ways to reduce or eliminate the tax.
A profitable home sale is a goal for most buyers, and the government supports this by offering the home sale exclusion when filing taxes after selling the residence. It's known as the primary residence exclusion.
Joint tax filers can exclude up to $500,000 in capital gains with this benefit. Single filers exclude up to $250,000. Beyond these amounts, profits are counted as capital gains income, and they’re taxed.
There are restrictions on these exclusions. However, military members have their own set of stipulations to offset residency rules.
Exclusion eligibility generally includes three criteria:
- The house was a primary residence for at least 2 of the preceding 5 years
- The owner must have owned the home for a minimum of 2 of the preceding 5 years
- The owner can’t have used the exclusion in the previous two years
These are known as the “2 of 5 years rule” or the “use test.” It establishes whether the service member lived in the home as a permanent residence. Meeting this requirement can be difficult for military families who move frequently.
Suspension of Time for Service Members
Suspension of time allows for the “2 of 5 years” rule to pause if a service member receives military PCS orders that move them more than 50 miles from their home. This suspension is in effect for only ten years, and it has a look-back period of 15 years. The homeowner cannot suspend more than one property at a time.
For service members approaching retirement, meet with a professional to discuss any tax consequences of selling the home. Suspension of time is a complicated and unclear law when a service member nears retirement. This analysis can be added to the list of military retirement tasks.
How Capital Gains Taxes Are Calculated
If a seller profits from the sale of a primary residence, that profit is considered a capital gain, and the federal government taxes it as income. However, single filers may qualify for up to $250,000 in capital gains tax exclusion, and those filing jointly may qualify for up to $500,000.
For short-term capital gains on property owned less than one year, the tax is based on the owner's income tax rate or tax bracket. Long-term capital gains on property held for over one year are 0%, 15%, or 20%, depending on taxable income and filing status. Long-term capital gains are typically taxed at lower rates than short-term gains.
The amount of tax owed is determined by how long the owner held the property before selling it. Each year, the IRS determines the capital gains tax rates for long- and short-term asset ownership.
How much tax do you pay when selling a house? The IRS 2025 Capital Gains Tax Rates provides more information.
Cost Basis and Net Sale Price Determines the Amount of Capital Gains
To illustrate, consider a married couple who filed jointly, bought a $200,000 house, and then sold it 10 years later. The couple would not owe any federal taxes on the net proceeds unless the home sells for more than $700,000.
Most military home sellers, who aren’t eligible for the full exemption, must calculate both the cost basis and the net sale price to estimate the amount of capital gains tax owed.
There are two key figures. Cost basis is the total amount paid to buy the house. These include acquisition costs, like origination fees, and capital improvements such as renovations and new appliances. Second, net proceeds are the final amount the home sold for, and this is after subtracting fees such as real estate agent commissions.
If the home is sold at a profit, this equation can reduce capital gains and help the seller avoid capital gains taxes.
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Photo from iStock.com/Jaskaran Kooner
Tax Implications of Selling a Rental Property
When a military family decides it’s time to sell a rental property, either because landlord life has run its course or the investment no longer makes financial sense, it’s important to understand what the financing for the sale entails. There will likely be more financial transactions than simply collecting proceeds. Be prepared to pay taxes on the home sale.
Understanding Depreciation Recapture
Just like a vehicle, a rental property depreciates every year. This means the structure, but not the land it sits on, loses some of its worth. Each year, the IRS offers tax breaks on this depreciation, and it can benefit property owners.
However, when it’s time to sell, the IRS requires that the depreciation benefit be returned; this process is known as depreciation recapture. If the home sells for more than its depreciated value, the owner must pay the taxes previously avoided through depreciation.
How Depreciation Recapture Is Taxed
The amount of depreciation varies depending on the value of the rental property and the owner's tax bracket. The majority of military families fall into the 10% or 15% nominal tax bracket.
Underestimating depreciation recapture taxes is a common, but costly, mistake that many military landlords make. It often turns what seems like a profitable investment into a money pit at the time of sale. Homeowners must conduct a thorough profitability analysis with qualified real estate professionals early in the buying process.
Ways to Reduce the Tax Burden
For real estate investors, the goal is to maximize profit from a rental property. Although it’s typically a substantial long-term investment, the rental will not always yield net gains. The owner may owe thousands in taxes at the time of sale. However, there are workarounds to alleviate the tax burden, especially for active-duty military members.
Convert the Rental Property into a Primary Home
Moving into a rental home long enough to meet the capital gains exemption requirements is possible, though preparing for a long-term stay in one location can be difficult for active-duty service members. Requirements to qualify for the exemption include details from the “2 of 5 years rule” as mentioned earlier.
The 1031 Exchange
The number 1031 refers to Section 1031 of the Internal Revenue Code, also known as a "like-kind exchange." This provision allows a homeowner to sell a rental property and reinvest the proceeds into a like-kind asset.
Homeowners consider this exchange when they anticipate significant capital gains taxes, when they’re looking to save on depreciation recapture, or when a fast transaction is necessary. Under a 1031, the owner does not recognize losses or gains at the time of the sale. The capital gains taxes are deferred until the replacement property is sold. A 1031 does not eliminate taxes; it simply defers the payment date.
A 1031 exchange must also meet these criteria:
- Investment property, commercial property, personal property, and trade property are the only eligible types. Personal residences do not qualify.
- Like-kind property exchanges must be the same type: real property for real property, not real property for personal property.
- There is a set 45-day window to identify the replacement property.
- Sale proceeds must be reinvested in like-kind property, and the exchange must close within 180 days.
A 1031 exchange is a complicated matter that requires a professional intermediary with years of experience.
Learn more: Extending the Capital Gains Exclusion for Military Rental Properties
Plan an Exit Strategy Before Buying a Home
Successful home sellers buy their homes with an exit strategy in mind. Without a detailed investigation of what selling options will look like in the upcoming years, homeowners can't know what the financial outcome of their real estate purchase will be. Rental properties, in particular, have a precise profit-and-loss equation that must be worked through to avoid unexpected taxation.
Military homeowners should not overlook the limits of an initial real estate investment. Preparing for the upfront costs of purchasing the home is important, but so is considering the tax implications of the profit upon selling. Thinking through the full picture, from purchase to sale, is a crucial part of homeownership that is often forgotten.
By Dawn M. Smith