Tax benefits for military personnel.

• Author: Evans, Lorraine D.

A number of provisions in the Military Family Tax Relief Act of 2003 (MFTRA) (1) and the Working Families Tax Relief Act of 2004 (WFTKA) (2) grant tax relief to military personnel and their families. While relief from the ownership and use tests under the Sec. 121 exclusion for personal residence sale gain was the most anticipated of the MFTRA changes, taxpayers will also benefit from an increased exclusion of death benefits, favorable travel expense deductions, expansion of filing extensions and changes in the tax treatment of withdrawals under Coverdell education savings accounts (ESAs) and qualified tuition plans (QTPs). More favorable treatment of excluded combat pay when computing the child credit and the earned income credit (EIC) round out the MFTRA benefits. The provisions have varying effective dates; thus, it is essential to timely file various elections and amendments and 2004 returns.

Personal Residence Sales

Sec. 121 provides that taxpayers may exclude up to $250,000 ($500,000 for certain joint fliers) of the gain on the sale or exchange of a principal residence. To qualify for the full exclusion, the taxpayer(s) must have owned and used the home as their principal residence for at least two years of the five-year period ending on the sale or exchange date. Kegs. Sec. 1.121-1(c)(2)(i) suggests that short temporary absences (e.g., vacation and seasonal allowances) will not disqualify taxpayer(s) for the exclusion.

Under MFTRA Section 101(a), creating new Sec. 121(d)(9), the running of the five-year period for ownership and use may be suspended by election during any time an individual or his or her spouse is serving on qualified official extended duty as a member of the uniformed services or the Foreign Service. According to Sec. 121(d)(9)(B), the five-year period may not be extended for more than 10 years. This provision applies to sales or exchanges after May 6, 1997, under MFTRA Section 101(b)(1).

For election purposes, Sec. 121(d) (9)(C)(i) defines "qualified official extended duty" as any extended duty while serving at a duty station at least 50 miles from the residence or while residing under government orders in government quarters. Sec. 121(d)(9) (C)(iv) defines "extended duty" as any period of active duty pursuant to a call or order to such duty for a period in excess of 90 days or for an indefinite period.

Under Sec. 121(d)(9)(C)(ii), "uniformed services" are defined as in 10 USC Section 101(a)(5), and include the Armed Forces (Army, Navy, Air Force, Marine Corps and Coast Guard) and commissioned corps of the National Oceanic and Atmospheric Administration and Public Health Service. According to Sec. 121(d)(9)(C)(iii), "member of the Foreign Service of the United States" is as defined in Section 103(1)-(5) of the Foreign Service Act of 1980, as in effect on Nov. 11, 2003.

Example 1: Lieutenant B owned a house in Ohio and lived there from December 1990 until deployed overseas in January 1993. When he returned to the U.S. in July 2001, he was stationed 90 miles from his home. Preferring not to commute, he sold the house four months later for a $150,000 gain. Because B had not used the home as his principal residence during the five years preceding the sale, he reported the capital gain on his 2001 return.

After the MFTRA, B can disregard both the 8 1/2 years he was stationed over seas and the four months after his return to the U.S. and before the sale, as he was stationed more than 50 miles from his former residence. B's five-year test period for ownership and use consists of the five years before January 1993. Because B owned and lived in the house for more than two years during the test period, he can exclude the sale gain. Assuming he filed his 2001 return before April 16, 2002, B must file an amended return by April 15, 2005, to recover the capital gain tax paid on the 2001 return.

Example 2: The facts are the same as in Example 1, except that when B returned to the U.S., his duty station was only 40 miles from the house. Thus, only the time overseas can be disregarded. B's five-year test period for ownership and use consists of the four months in 2001 and the 56 months before January 1993 (when he...