There's great news for military landlords who sell a rental property shortly after retirement! You may be able to use the military extension to exclude some or all of your capital gains, even though you're no longer on active duty.
The profit earned on the sale of a house is considered taxable income, taxed at the "capital gains" rate. However, federal law allows you to exclude up to $250,000, per spouse, of profit if you lived in the property for two out of the last five years. The exclusion is designed to lessen the tax burden on average Americans who aren't using real estate as a way to generate income. The "2 out of 5" rule makes allowances for things like houses not selling quickly, or the need to rent for a few years before selling.
Unfortunately, many military families become accidental landlords when they buy a house and then receive Permanent Change of Station (PCS) orders to a new location. Whether the market tanked, or they didn't put any money down and so don't have any equity, renting can be a way to cushion the blow until a homeowner can afford to sell. Whatever the reason, lots of military families end up owning rentals, often for years.
To reflect the fact that military families don't get to choose whether to move, the law allows for a ten year extension of the 2 for five rule if the service member is permanently assigned to a duty station more than 50 miles from the property, or if ordered to move into military housing. This means that 2 out of 5 can turn into 2 out of 15.
Now, here's the really good part for retirees:
According to the IRS's Volunteer Income Tax Assistance training program,
"This extension of time can apply to taxpayers who have recently left the military."
Of course, there is no provided definition for "recently," and I can't find any case law that applies, so you and your accountant will have to consider this carefully. But just knowing that the IRS says that it can be done is an amazing piece to add to your long-range planning tool-kit.
- The extension can only apply to one property at a time. If you've got multiple properties, you'll need to do some careful and creative timeline study to see how to make this benefit you the most.
- I have yet to find any IRS guidance on using the extension if you move back to the area of the property. My guess is that it would not apply. Again, consult with your tax professional.