Paycheck Chronicles

From The Mailbag: Capital Gains Math

Updated on 12 July 2017 to include information about how retirement impacts the military extension.  Thank you to my friend and smart money guy Forrest Baumhover for pointing out that I hadn't addressed this issue.

The military extension for the capital gains exclusion is one of those rules that is mis-interpreted all the time.  It's easy to understand why - it's got some numbers, and then some other numbers, and then you have to put them on top of each other.  It can be easier to understand if you break it down into its two parts two parts:  the capital gains exclusion and the military extension.

Dear Kate,

I was reading on your blog about capital gains. Your blog was very helpful and informative. My husband is active duty. We bought a house in Virginia in May of 2004. Lived there until June of 2009. Started renting it on July 1 of 2009. When do we have to sell by to avoid capital gains? June of 2017 or June of 2019?We have neither lived in it again nor have we been stationed within 50 miles of it while renting it out.

We still own it, did we miss the deadline?

Sherry

This is the kind of math that seems harder than it actually is, but it can definitely be confusing.

Dear Sherry,

From what you have described, it sounds like you need to sell by June of 2022.  Here's how I come up with this:

The regular rule, for everyone, is two out of five years.  If you were using the regular rule, you would have to sell by June 2012.  If you sold in June 2012, then you would have lived in the house for two years (June 2007 to June 2009) out of the previous five (June 2007 to June 2012.)

The military extension allows you to suspend the time clock for 10 years.  You can suspend the time between June 2012 to June 2022.

Please note that this is not professional tax advice.  Please do your own research and check with your financial or tax advisor to be sure this will apply to your specific situation.

Good luck to you,

Kate

One thing I forgot to mention is that the extension can possibly extend into retirement, but the IRS is remarkably unclear about how that works.  If you aren't going to sell a rental property before you retire, you want to carefully explore this rule with your tax professional.

Many military families are lucky to just break even on the sale of a home, but a lucky few actually have a capital gain at the time of the sale.  The military extension means that some military members may be able to exclude the capital gain from taxation even if they don't meet the regular two out of five-year residency requirement.

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