what to know about taxes when selling your home
Using the VA loan to invest in real estate is a great way for service members to achieve their financial goals. An investment property can bring in cash on a monthly basis while building equity over time. Countless service members have done this, and many more do so every year.
Each PCS season, however, many personnel opt to sell rather than rent. This is a complicated decision, and ultimately comes down to individual preference and circumstance. Regardless of preferences, intentions, and circumstances, it’s important for any homeowner to understand tax liability when selling a home. We’ll walk you through it. Let’s walk through it.
In This Article
Big Picture
Whether you’re looking to sell a home soon after buying it or several years down the road, you’ll want to understand the tax implications. If the home you’re selling is your primary residence and you’ve owned it for more than two years, there’s a good chance you’ll be able to sell it without paying capital gains taxes. If you’ve had it for less than two years, you can expect to pay long term capital gains taxes, and if you’ve owned it for less than a year, expect to pay short term capital gains. That said, there are some tax breaks that might apply depending on your situation. Some of these are unique to military personnel, and all are worth knowing about.
Capital Gains 101
The topic of capital gains can get complex, but a basic understanding of how these taxes work goes a long way. When you sell an asset for more than you bought it for, you’ll pay capital gains taxes on the profit. The amount you pay depends primarily on how long you owned the asset.
Short Term Gains
If you hold an asset for a year or less, expect to pay short term capital gains taxes, which match income tax rates. To see what tax bracket you’re in, check out the IRS website or use the calculator below.
Brackets reflect rates for 2022 according to the IRS. ‘Marginal Tax Rate’ is the tax that you’d expect to pay on the next dollar you make.
Long Term Gains
If you hold an asset for more than a year, expect to pay long term capital gains taxes. These are pretty straightforward, and easier on your wallet than their short term counterparts. Match up your filing status with your taxable income to see where you land.
Tax Rate
0%
15%
20%
Single Return
$41,675 or less
$459,750 or less
More than $459,750
Joint Return
$83,350 or less
$517,200 or less
More than $517,200
Ben’s annual taxable income is $65,000, which puts his marginal tax rate at 22%. In August of 2019, he bought 40 shares of stock X at $100 per share, and sold them just after Christmas at $140 per share for a quick profit. His capital gains are $1600, with a short term capital gains tax of $1600 x 22% = $352.
Ben’s buddy, who has the same income and bought the same amount of the same stock at the same time, waits until October to sell at the same price of $140 per share. His tax liability is a bit less, with the long term capital gains rate resulting in a tax ($1600) x (15%) = $240.
Selling After 2 Years
If you’re selling your primary home after owning and living in it for two (or more) of the last five years, there’s a good chance that you’re exempt from capital gains taxes on the first $250,000 of profit ($500,000 if married, filing jointly). The specific requirements are as follows:
By definition, you only have one principal residence at a time. For a service member that’s looking to sell a home on their way out of a duty station, the home almost certainly meets the principal residency test. If you’re looking to sell a home that you rented out for a while, it’s possible to claim it as your principal home, but a bit more nuanced. Again, the key idea is that you can only have one primary residence at a time.
You and/or your spouse owned the home for at least 24 months of the five years leading up to the sale. If you’re married filing taxes jointly, only one of you needs to meet the ownership requirement. If it’s been longer than five years, there’s a period of suspension which allows you (if you’re a service member) to suspend this five year period, which may apply.
You (and your spouse, if married) used the home as your residence for at least 24 months (730 days) out of the past five years. It doesn’t need to be all at once. If you’re married, you both need to meet this requirement, though the residency doesn’t need to be simultaneous to count towards either person’s tally.
You didn’t take an exclusion on the gain from the sale of another home for the 2 years leading up to the sale. You can only do this once during any 24 month period.
If all of these apply to the sale of your home, congratulations. The first $250,000 (or $500,000 if married) of profit isn’t subject to any capital gains taxes. If your gains exceed that limitation, then seriously, congratulations.
Selling Before 2 Years
If you’re selling your house between one and two years, it’s viewed as a long term capital gain. This is big for service members on two year orders who buy on their way into a duty station and sell on the way out. Depending on the closure dates for buying and selling, a difference in a week or two could be the difference between a 15% gains tax or pocketing the entirety of the profit. See below for an example of how timing can come into play as well as a long terms gains calculator.
Timing Example
Buy
June 15th, 2021
June 15th, 2021
Sell
June 7th, 2023
June 22nd, 2023
Capital Gains
Long Term
Exempt
Long Term Gains Calculator
Selling Before 1 Year
If you’re selling your home before owning it for a full year, your profit it is viewed as a short-term gain and is taxed accordingly. However, if you moved for a specific reason, you might qualify for a partial deduction that could limit or eliminate your tax liability. Most frequently, these exemptions apply in situations where the move was unforeseen and necessary for the sake of work and/or health.
Partial Exclusions
If you don’t meet the two year residency requirement for the full exemption but find yourself moving for work, health-related reasons, or other unforeseen circumstances (like having twins), you might be able to claim a partial exclusion.
What Qualifies?
To qualify for a partial exclusion, the primary reason for selling your home must be the result of a medical issue, a change in your place of employment, or another “unforeseeable event”.
1. Employment Exclusion
If either of the following is/are true of yourself, your spouse, or another co-owner of the home, you qualify for a work-related partial exclusion.
- You had no place of employment previously, and began a new job at least 50 miles from the home.
- You were transferred to or began a new job at least 50 miles farther from your home than your previous place of employment.
2. Medical Exclusion
If any of the following is/are true of yourself, your spouse, another co-owner of the home, or anyone else using the home as their primary residence, you qualify for a health-related partial exclusion.
- A doctor recommended it because of a medical issue.
- You moved to ensure or facilitate healthcare in the event of illness, injury, or disease or yourself or a member of your family.
- You moved to ensure adequate medical or personal care was available for someone from your extended family:
- Children, step-children
- Siblings, step-siblings, half-siblings
- Parents, grandparents, step-parents
- Aunt, uncle, niece, nephew
- In-laws
3. Unforeseeable Events Exclusion
There are additional categories that may qualify you for a partial exclusion that the IRS labels “unforeseeable”. Very few are positive life events, but they’re good to know about in the event that you’re moving as a result of one of them. Divorce, legal separation, unemployment, inability to keep up with basic living expenses due to a change in employment status, and the death of a spouse, co-owner, or primary resident are all events that qualify for a partial exclusion. On a lighter note, so does giving birth to twins (or more)… so take that for what it’s worth.
4. Other Legitimate Reasons
If you’re moving for a reason similar to those above, but don’t perfectly fit into any of the categories, it’s still possible to qualify for an exclusion. Generally, the primary reason for selling your home must be unforeseeable or related to health or work. Here are a few questions to ask up front to see if you might qualify.
- Did a circumstance arise while you owned and were living in your home that you couldn’t have reasonably anticipated?
- Did the circumstance result in financial hardship in keeping your home?
- Did the home become a (much) worse residence for you and your family due to this circumstance?
- Did you sell your home shortly after the circumstance happened or began?
If the answer to these questions are yes, it’s important to bring a tax professional on board to help you navigate the process and ensure you’re filing correctly. To obtain the partial exclusion, you must demonstrate why and how you qualify for it based on facts and circumstances. This can be as simple or complex as your unique circumstance, but is certainly something that you’ll want to enlist the help of a pro for. If you qualify, they’ll help you do it right and ensure you receive your exclusion. If you don’t, they’ll be able to tell you before you file and anticipate your liability.
How it 's Calculated
Even though the exemption is only partial, it may still cover the entirety of your capital gains. It’s calculated in three basic steps. If you’re married, complete these steps for both you and your spouse, and add up the totals… Or just use the calculator.
Do it Yourself
- Choose the shortest time period from:
- Time you owned the home prior to the sale
- How long you stayed at your home in the five years prior to the sale
- How long it’s been since the last time (if ever) you took an exclusion on gains from the sale of a home
- Determine what portion of two years your result from Step 1 is.
- If counting in days, divide by 730
- If counting in months, divide by 24
- Multiply the number from Step 2 by $250,000.
- Married? Repeat 1-3 for your spouse and add the totals.
Smarter, not Harder:
Unique Military Benefit
Military Personnel can suspend their five year test period (in which they must have lived in the home for 2 of them) for up to ten years. Together, the test period and suspension period can last up to fifteen years. For service members who plan to return to their primary residence on a subsequent tour or after transitioning out, this can be huge.
Fine Print:
Military Personnel can suspend their five year test period (in which they must have lived in the home for 2 of them) for up to ten years. Together, the test period and suspension period can last up to fifteen years. For service members who plan to return to their primary residence on a subsequent tour or after transitioning out, this can be huge.