Homeowners in military winning capital-gains relief

Nation's Housing

April 06, 2003|By KENNETH HARNEY

THE WAR in Iraq may be moving slower than some analysts had predicted, but it definitely speeded up passage of legislation on Capitol Hill that will put millions of dollars a year in federal tax savings into the pockets of homeowning members of the armed forces.

After more than a year of false starts, Congress has just approved versions of the Armed Forces Tax Fairness Act, including long-awaited relief on home-sale capital gains. Though the bills passed by the House and Senate differed slightly, both chambers were expected to resolve their differences and send the legislation to the president for signing.

The home-sale capital gains provision would fix a widely acknowledged inequity in the federal tax code: Active-duty service personnel assigned overseas or at domestic bases in the United States frequently face sharply higher tax burdens than civilian Americans when selling a home. This occurs because of a drafting glitch in Congress' reform of the home-sale capital-gains rules in 1997. Essentially, the bill drafters forgot that members of the military frequently are out of the country - or away from the homes they own - for extended lengths of time. As a result, they sometimes find it difficult to qualify for Congress' 1997 capital gains tax-free "exclusion" rules.

Under those rules, home sellers can take up to $250,000 (single tax filers) or up to $500,000 (married joint filers) of their home-sale gains free of federal taxes, provided they have owned and occupied their homes as their principal residence for an aggregate two years in the five years preceding the date of sale.

Sellers who don't qualify under the two-out-of-five-year standard may be able to take a "partial exclusion" if they were forced to sell early because of a change in employment, a health-related problem or an "unforeseen circumstance." The IRS consistently has refused to interpret the 1997 law to permit armed forces members posted to overseas or domestic duty posts for multiyear periods to receive any special break on the strict two-year occupancy rule.

As a result, many members of the military end up paying tens of thousands of dollars in taxes because they rented out - or did not personally occupy - their homes.

How costly can that be? The new legislation is expected to save home-selling members of the armed forces a combined average of $23 million per year in federal taxes for the next decade. To illustrate how the 1997 law adversely affected service personnel, consider this hypothetical example:

Say you are career Army, and own a home near your base in the United States. You are transferred to a series of active-duty assignments in different countries totaling five years. While you are overseas, you rent out your house. While you are away, the housing market booms and your home jumps sharply in resale value. When you return home with your spouse and decide to sell the house, you discover to your delight that you're likely to net $400,000 in profit on the sale.

But here's the glitch: Your house has not been your principal residence for the required two of the preceding five years. Nor do you qualify for a partial exclusion under IRS regulations.

You're stuck with an $80,000 (20 percent) federal capital gains tax on your sale proceeds plus possibly a state capital-gains levy - taxes that you'd never have faced had you not been overseas on orders of the federal government.

The new legislation would correct the problem by suspending your years overseas from the capital gains two-out-of-five-year test.

In the House-passed bill, the suspension can run for as long as five years; in the Senate-passed bill, the suspension can go for up to 10 years.

The House legislation requires military personnel to be on "qualified official extended duty" to receive the suspension. That means any extended duty over 180 days at a duty station at least 150 miles from the service member's home or when residing under government orders in government quarters. The Senate-passed version lowers the duty station's minimum distance from home to 50 miles and the minimum time away from home to just 90 days to trigger the suspension.

Thousands of military personnel per week are being added to the pool of potential beneficiaries of the new legislation. According to Pentagon estimates, 217,000 reservists have been called to active duty to assist in the war effort.

"Our enlisted men and women are front and center," said Sen. Charles E. Grassley, the Iowa Republican who is co-author of the Senate-passed version of the bill. "The sad fact is these folks don't get a fair shake under the federal tax code."

Now they will when they sell their homes.

Ken Harney's e-mail address is kharney@winstarmail.com.

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