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Many military families end up owning rental properties, which can 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 all income received from the property that year, then reduce your income by the amount of 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 reported on Schedule E may increase or decrease 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.
MilTax: Impacted by COVID-19?
Schedule a free, personalized consultation with a MilTax consultant to learn more about how COVID-19 may impact your specific situation. MilTax consultants are trained tax experts who can help you address the realities of military life, from rental properties to combat pay.
Taxes when you sell your rental property
When you sell a rental property, you may have to pay capital gains taxes and recaptured depreciation taxes, technically called unrecaptured section 1250 gain.
Capital gains taxes are based on any profit made on the sale of your rental property, as determined by subtracting the purchase price and any improvements from the sales price. There are two rules that may help military families exclude capital gains from taxation.
The first rule applies to all taxpayers. The capital gains exclusion permits taxpayers to exclude a certain amount of profit from their taxable income as long as they have lived in the house, as a primary residence, for 24 out of the previous 60 months. The amount that can be excluded is $250,000 for a single taxpayer and $500,000 for a married couple filing jointly. This means that as long as your profit is below these amounts, and you meet the residency requirement, you aren’t taxed on the profit.
The second rule is the military extension of the capital gains exclusion. This allows active-duty military members who are away from their property due to PCS orders to extend the 60-month period up to an additional 10 years. This means that eligible military members may exclude their capital gains as long as they occupied the primary residence for two of the previous 15 years.
There are special limitations for situations in which a homeowner moves back into a previous rental property.
Recaptured depreciation is a separate part of the calculation that takes into account the depreciation that you’ve taken over the years that the property has been a rental. It’s very important to note that you are subject to taxes on that depreciation whether you actually took the depreciation or not.
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.
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.