2/5 Rule for Sale of Two Properties While in Military

[sharonli1138]

Im active duty military, and am planning on selling one of my homes (Property #1) in the next several months, which meets the 2/5 capital gains tax exclusion criteria of having both owned and lived in it for 2 of the last 5 years prior to selling (and my understanding is that the rule actually extends to 15 years for the military). My tenants in a different property (property #2) have interested in purchasing my home, and we had agreed on a deal several months ago, but at the time, they could not secure financing, so they continued renting. They unexpectedly reached out today and stated they they were close to getting financing, and asked if I’d honor the deal we originally agreed on. I’d meet the 2 of 15 rule (But not 5...I lived there prior to property #1)l and the total capital gains tax would not exceed $250k. However, since the sale would take place around the same time, am I correct in assuming that only one would be exempt? The gains for Property #1 would be significantly bigger, so would I need to sell that one first? Even though both meet the 2 of 15 rule (and I moved out of both due to military re-assignment).

[pk]

@sharonli1138   two points:

1. Note that the basis of the rental property  would be reduced  by allowable depreciation and thus not only will increase the gain but also treat  the gain caused by depreciation as ordinary income  ( and cannot be excluded )

2. For exclusion of gain you need to satisfy  (a) 2 out of  5 rule  -- two years of ownership and  730 days  total of use as main home with a look back period of five years   and (b) cannot have claimed this  exclusion in the last two years from the date of sale.

 The above is for everybody and so probably applies the same way to Military also - except for  five being replaced by 15  ( for look back ) ----- this suspension  of the look back is ( for specific groups --see below ) is 10 years  i.e. a total of 10 plus the usual  5  equal to 15.

From  Pub 523:  ( https://www.irs.gov/publications/p523#en_US_2019_publink10008962 )

Service, Intelligence, and Peace Corps personnel.

If you or your spouse are a member of the Uniformed Services or the Foreign Service, or an employee of the intelligence community in the United States, you may choose to suspend the 5-year test period for ownership and residence when you’re on qualified official extended duty. This means you may be able to meet the 2-year residence test even if, because of your service, you didn’t actually live in your home for at least the 2 years during the 5-year period ending on the date of sale.

Qualified extended duty.

You are on qualified extended duty if:

• You are called or ordered to active duty for an indefinite period, or for a definite period of more than 90 days.

• You are serving at a duty station at least 50 miles from your main home, or you are living in government quarters under government orders.

• You are one of the following:

  1. A member of the armed forces (Army, Navy, Air Force, Marine Corps, Coast Guard);

  2. A member of the commissioned corps of the National Oceanic and Atmospheric Administration (NOAA) or the Public Health Service;

  3. A Foreign Service chief of mission, ambassador-at-large, or officer;

  4. A member of the Senior Foreign Service or the Foreign Service personnel;

  5. An employee, enrolled volunteer, or enrolled volunteer leader of the Peace Corps serving outside the United States; or

  6. An employee of the intelligence community, meaning:

     1. The Office of the Director of National Intelligence, the Central Intelligence Agency, the National Security Agency, the Defense Intelligence Agency, the National Geospatial-Intelligence Agency, or the National Reconnaissance Office;

     2. Any other office within the Department of Defense for the collection of specialized national intelligence through reconnaissance programs;

     3. Any of the intelligence elements of the Army, the Navy, the Air Force, the Marine Corps, the Federal Bureau of Investigation, the Department of Treasury, the Department of Energy, and the Coast Guard;

     4. The Bureau of Intelligence and Research of the Department of State; or

     5. Any of the elements of the Department of Homeland Security concerned with the analyses of foreign intelligence information.

Period of suspension.

The period of suspension can’t last more than 10 years. Together, the 10-year suspension period and the 5-year test period can be as long as, but no more than, 15 years. You can’t suspend the 5-year period for more than one property at a time. You can revoke your choice to suspend the 5-year period at any time.

[AmeliesUncle]

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@sharonli1138 wrote:

my understanding is that the rule actually extends to 15 years for the military.

I moved out of both due to military re-assignment).

The gains for Property #1 would be significantly bigger, so would I need to sell that one first?

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First, just to clarify, it is not an automatic 15 years.  It is UP TO 15 years.  It is 5 year plus the number of years you were in the military during that time.  So if you were in the military for 3 years, then the rule would be 2 out of 8 years.  Based on everything else you said it seems like you probably meet that criteria, but I just wanted to clarify that.

You are right, the usual rule is that you can only "exclude" one house every two years.  But it not a mandatory thing, so if you are selling both houses that qualify, you can choose whichever one you want to use it on.   It doesn't matter which one is sold first.

It is a bit complicated (and somewhat against logic), but it sounds like you might actually qualify for an exclusion for both houses.  Sort of.  In this scenario, you would want to sell the bigger profit one first (house #1) to receive the full exclusion.  For the second house, assuming you got your reassignment when you lived there and it was at least 50 miles further away, that would qualify as a "job change".  The bizarre and illogical part is the "job change" from the house #2 was BEFORE the your "job change" from house #1.  But the way I read the Regulations, it still qualifies under the "job change" rules.

For a "job change", you can get a prorated exclusion.  As I mentioned above, the 'usual' rule is that it must be at least 2 years (24 months ... note this "24" for the next calculation) apart to exclude a home.   So because of the "job change", you can prorate it.  If the sale is 3 months apart, your maximum exclusion would be 3/24ths of $250,000.  As I said before, you would want to sell the first one first, because you probably don't want to prorate the higher-profit house; you would want to prorate the lower-profit house.