Tomorrow is tax day (and, coincidentally, the anniversary of the Titanic sinking). I wanted to pass along this tip that could save you up to $75,000 in taxes that I’m surprised more people don’t know.

For those of you who actually know me, you’ll remember that I was conducting real estate settlements in DC before joining the Foreign Service.  I liked learning the intricacies of real estate law but one thing stuck out at me: active duty military and Foreign Service Officers have a much longer window to sell a house and claim up to $500,000exemption on the capital gains from the home sale. Most people know about the 2 years in 5 rule, by which you can exempt your primary home from capital gains if you lived in it for two out of the five years before you sold it. The exemption is $250k for individual filers and $500k for married couples filing jointly. The special rule for FSOs is that you can suspend your five-year test period for up to 10 years if you’re on assignment away from your home — effectively giving you a 2 year in 15 rule!

For example: say I bought an apartment in DC for $200,000 in January 2001 and lived in it as my main home through July 2004 when I was posted overseas. In the five years since then, say I’ve acquired several children, rugs, and large non-embassy furniture and I need a bigger place. In this fantasy equation, I sell the house for $500,000. Your real estate agent and possibly even your tax preparer may think you’re on the hook for $300k in gains on the house ($45,000 tax liability) because you fail the 2 in 5 tests. Au contraire! The example STILL works if I had lived in the house from 1996-1999 and have been overseas since (the publication actually doesn’t make the distinction that you have to be overseas though it does for members of the intelligence community. I’d rather not have my readers be tests cases, but you could always check with a lawyer to see if it applies while you’re domestic).

The full rules for this are explained in IRS Publication 523. If you’re not sure, talk to a tax professional or a lawyer. Another option that requires much more foresight than the previous example would be a “Starker” 1031 exchange, which I can get into at a different time.  It’s useful, though, to point this out to real estate folks in DC because most of them are shocked to know it and wouldn’t be in a position to even advise you on it (though I think I remember the excellent Benny Kass mentions it in one of his WaPo columns.

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