Do I qualify for the home sale capital gains exclusion extension as a DoD civilian overseas?

[BSSD]

We are planning to sell our primary home soon, but need to clear up a timeline that could prove expensive.

Evaluating Publication 523…

• None of the automatic disqualification reasons apply to us.
• The home was purchased in 2010 and has been our primary residence.
• We lived in the home until moving to Germany in July 2021.
• We are married filing jointly.
• The profit from the home will be less than $500k

Based on that, I believe I would have to sell by July 2024 to avoid capital gains.  However…

• Eligibility exception – qualified extended duty.
  • I am a Department of Defense civilian on orders working in Germany.
  • I do work for an employer listed under ‘qualified extended duty’.
  • I am not active-duty uniformed service military.
  • We will be stationed in Germany from 2021-2027.
  • Germany is more than 50 miles from my state.
  • I do not live in military housing.
  • I own no other home.
• The home has been rented out since July 2021.

Questions:

• Am I correct in believing we qualify for this extension exemption?
• How do I prove ‘qualified extended duty’ beyond my official orders? (DD1614/SF-50)
• If we stay in Germany as expected until July 2027, what would be the latest we could sell and still be exempt from capital gains?

Thanks for any help and advice. 

[tagteam]

@DoninGA may have some insight here.

[Opus 17]

Military service (or being overseas on orders as a civilian) suspends the five-year clock by up to 10 years.  That means that, since you moved out in 2021 and would normally be required to sell the home by 2024, you can extend that up to 2034.  However, I’m not sure how the extension operates if you return to the US in 2027. You probably want to sell the house before 2027 just to be safe, although another expert may have a more clear view on that.

One definite mistake would be to move back into the home and begin using it as your main home again when you return to the states in 2027. If you move back into the home, you run into an issue called “nonqualified use” which would make a large portion of your capital gain no longer eligible for the exclusion.  The idea of the exclusion is that if you move out, and then sell without moving back in, you can use the full exclusion. But if you move out, rent for a while, and move back in, you can’t use the exclusion to convert the taxable capital gain due to the rental period into non-taxable capital gain.  Moving back into the house would defeat the exclusion. You want to sell it without moving back into it, possibly by 2034, and possibly by 2027.

Also note that, even if you qualify for the exclusion, you must pay depreciation recapture tax on the depreciation that you claimed or could have claimed during the period of time the home was a rental.

You don’t submit any proof when you file your tax return that you qualify for the extension due to military service or civilian orders. Keep whatever proof you have with your other important tax papers for as long as you own the home plus 3 years after you sell, in case of audit.  

[DoninGA]

The IRS is fairly specific on the types of civilian employment is eligible for the Qualified Extended Duty when selling a personal residence.

Since you are a DoD employee then assume your duties would be covered by the following for the QED -

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

If so, then after your duty in Germany is completed, again assuming you will be working in an eligible position, you can sell your personal residence within two years after the duty ends in July 2027.  So selling by July 2029 would give you the exclusion.

You would need to retain all paperwork from the employer that describes your position and validating your length of duty in the position while in Germany.

Also, when the home is sold the depreciation taken has to be recaptured when it was a rental.  You will have to pay capital gains on the recaptured depreciation.  This is separate from the capital gain exclusion when selling the personal residence.