Many military families choose to keep their home as a rental property when duty calls them elsewhere. Renting out a property can help build wealth, but it can also bring special tax challenges.
Here’s what you need to know to understand the potential tax impact of your rental property.
Your annual tax return
Each year that you own a rental property, you will need to complete an IRS Schedule E form to report your income and expenses. You’ll report the year’s income from the property, then reduce your income by your expenses, including mortgage interest, insurance, taxes and property management. You will also depreciate the value of your investment using Form 4562.
The income, expenses and depreciation may raise or lower your overall taxes each year. However, it is important to remember that the depreciation will impact your taxes when you sell. Read IRS Publication 527.
Rental income and losses are generally considered “passive.” That means you can’t always deduct all your rental losses right away. The IRS has rules called “at-risk” and “passive activity loss” limits that decide how much you can claim. Form 6198 and Form 8582 help figure this out. See IRS Publication 925 for details.
Taxes when you sell your rental property
When you sell a rental property, you may owe two types of taxes:
Capital gains taxes. This is based on the profit made from the sale of your rental property. Determine capital gains by subtracting your purchase price and any improvements from the sales price.
Schedule a free, personalized consultation with a MilTax consultant
MilTax consultants are trained tax experts who can help you address the realities of military life, from rental properties to combat pay.
Depreciation recapture tax (called “unrecaptured Section 1250 gain”). For residential rental property in the U.S., you must depreciate the building (not the land) over 27 1/2 years. This lowers your taxable income each year, but it also lowers your property’s value for tax purposes. When you sell, the IRS makes you “recapture” all the depreciation you claimed, or could have claimed, and taxes it as regular income.
Two rules may help military families reduce or avoid capital gains tax:
Home sale exclusion. If the property was your main home for at least 24 out of the previous 60 months, you can exclude $250,000 of profit if you’re single, or up to $500,000 if you’re married and filing jointly.
Military PCS exception. If you’re on active duty and receive PCS orders, you can “pause” the 60-month clock for up to 10 years while you’re away. This means you may exclude capital gains as long as you occupied the primary residence for two of the previous 15 years.
If you rented out the property after moving out, special rules apply:
- You can’t exclude the profit from any time after 2008 when the home wasn’t your main residence.
- The tax break has to be split based on how long you lived in the home versus how long it was rented.
Keep detailed records of when the property was your main home and when it was rented.
Military members who are selling a house should consult IRS Publication 523, Selling Your Home. Another good resource for military-related tax questions is the IRS’s Publication 3, the Armed Forces’ Tax Guide.
Additional considerations for military landlords
Multistate filing obligations
If your rental property is in a state other than your legal residence:
- You generally must file a nonresident return for that state and report rental income there.
- Your home state may allow a credit for taxes paid to another state.
- The Veterans Auto and Education Improvement Act permits spouses to retain their home state tax residency, but does not exempt rental income from the property state’s tax.
Moving back into a former rental home
If you move back into a home you once rented out, then sell it, you can only exclude the profit from the time it was your main residence. Any gain tied to rental periods after 2008 is taxable. Also, if you claimed depreciation while renting, that part is always taxable – you can’t exclude it.
Record keeping and professional help
Managing taxes on rental properties requires careful documentation.
- Keep thorough records: Maintain a separate bank account for rental transactions, save receipts for income and expenses, and track the dates you lived in the property versus when it was rented. Retain depreciation schedules to calculate recaptured depreciation when you sell.
- Consult official IRS guidance:
When your situation is complex, such as multiple properties or multistate tax issues, consider working with a qualified tax professional or a tax consultant through Military OneSource.
Tax help when you need it most
Even when you understand the concepts, you may benefit from professional help with your income taxes. Military families can access free tax assistance from Military OneSource’s MilTax service or through the Volunteer Income Tax Assistance program.
MilTax is a suite of free tax services for the military, including easy-to-use tax preparation and e-filing software, personalized support from tax consultants and current information about filing taxes in the military. It’s designed to address the realities of military life — including deployments, combat and training pay, housing and rentals and multistate filings. MilTax is 100% free with no hidden surprises.
The VITA program offers in-person tax assistance at military locations worldwide, but VITA support is not available in every state or location. VITA volunteers are specially trained to address the tax questions of military personnel.
To be connected with a MilTax consultant or financial counselor, call Military OneSource at 800-342-9647 or log in to start a secure live chat. OCONUS/international? View calling options. Visit the Office of Financial Readiness website for additional tax resources, information and tips.
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