Military Update
Homeowners may get capital gains tax relief
Military Update focuses on issues affecting pay, benefits and lifestyle of active and retired servicepeople. Its author, Tom Philpott, is a Virginia-based syndicated columnist and freelance writer. He has covered military issues for almost 25 years, including six years as editor of Navy Times. For 17 years he worked as a writer and senior editor for Army Times Publishing Co. Philpott, 49, enlisted in the U.S. Coast Guard in 1973 and served as an information officer from 1974-77.
By Tom Philpott
With a sudden policy shift at the White House Office of Management and Budget, the Bush administration is solidly behind a proposal from Sen. John McCain (R-Ariz.) to give service members and U.S. Foreign Service officers the same tax breaks on home-sale profits available to other American homeowners.
About 350,000 service members — 22 percent of the active force — are homebuyers. But since passage of the Tax Reform Act of 1997, they and Foreign Service officers have suffered a tax disadvantage to other U.S. homeowners.
Current law allows individual taxpayers to exclude from taxes up to $250,000 in capital gains on the sale of a home. The ceiling is $500,000 for a couple filing jointly. To qualify, however, a taxpayer must have "owned and used" the property at least two of five years before the property is sold. So a homeowner assigned away from his or her principal residence more than three of the past five years faces a substantial tax bite on any profits from the sale.
The law, said McCain, "unintentionally and unfairly prohibits many of our men and women in the armed forces and Foreign Service from qualifying for this beneficial tax relief."
Service members, some argue, are being punished for the demands of that service. On average, they move every three years. Those who buy a home rarely see its value grow enough in three years to sell and avoid a net loss, after closing costs and commissions.
So military homeowners tend to rent out their homes while living elsewhere. Some expect to move back when reassigned to the area. Some never make it back, or they have families too large for the first house, and sell without reoccupying it. Sometimes they must sell to make a down payment on a new home or to regain their VA home loan benefits.
Whatever the reason, many military homeowners don't live in the homes they buy for two of the past five years before they sell, and therefore cannot shelter their capital gains from taxes like so many other Americans can.
Congress didn't intend to put military and Foreign Service homeowners at such a disadvantage, McCain told colleagues in introducing his proposal Nov. 12. Indeed, under the old tax law, military people were treated far more favorably.
Before May 7, 1997, taxpayers received a one-time tax exclusion of up to $125,000, on gains from the sale of a principal residence, but they had to be 55 or older at the time of the sale. To ensure that military homeowners could preserve capital gains until age 55, Congress gave them up to four years (eight if serving overseas) to roll over any profits into a new residence. Also, a service member assigned away, through multiple reassignments, could still maintain a designated "principal residence" for tax purposes.
The 1997 changes replaced the age requirement with the ownership and use requirement. It raised the tax exclusion ceilings and made it available as many times as a taxpayer can qualify. That was all good, McCain said. But amid the complexity, the law failed to protect service members and Foreign Service officers whose jobs require that serve long stretches away from home.
"We must not use the tax code to heap additional burdens upon our men and women in uniform," said McCain.
Under his "Military Homeowners Equity Act," active duty and reserve members would be deemed to be "using" their primary residences, for tax law purposes, if more than 50 miles away for "extended duty," which usually would mean 90 days or more.
To win passage this year, McCain will offer his bill as an amendment to the economic stimulus package moving through the Senate. The House has passed its version of the stimulus bill, a Bush priority, but with no relief for military homeowners. To become law, McCain's initiative not only must clear the Senate but also survive a House-Senate conference committee tasked to reconcile differences.
McCain hopes to have up to 25 co-sponsors by the time the amendment comes up for a vote after Thanksgiving. Service associations strongly endorse it. So too does Gen. James L. Jones, commandant of the Marine Corps.
Jones' note of support, signed Oct. 31, came as a surprise to some administration officials. The White House Office of Management and Budget had blocked past attempts for military capital gains tax relief.
Indeed, according to one report, OMB was blocking a joint endorsement of the bill by all four service chiefs.
OMB estimated that extending the tax breaks to military homeowners would lower government revenues by $5 million to $13 million a year, money that, under current budget rules, must be offset with equal cuts in spending.
OMB staff also had argued that the problem for military homeowners was overstated, that the full impact would be felt by relatively few, and that the change proposed would allow some military homeowners to treat what clearly is rental property as their principal residence to avoid capital gains tax.
Those positions were challenged in the wake of Sept. 11 and the war on terrorism. McCain personally called Sean O'Keefe, deputy OMB director, to review agency concerns. Richard Armitage, deputy secretary of State, was behind a State Department memo to O'Keefe Nov. 13 urging OMB support.
Two days later, OMB reversed course.
"After careful review," wrote Robin Cleveland, OMB associate director for national security, "there is a case to be made that the current capital gains tax system poses a burden on servicemen and women and foreign service officers. We should not penalize these Americans, in effect, for serving their country."
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