Calculating Capital Gains Exclusion & Depreciation Recapture on Home Sale with Gain Over $500K

What you're dealing with is a bit complex but can be broken down into manageable parts. The good news is that you likely still qualify for the $500K exclusion because you meet the ownership test (owned it for 8 years) and the use test (lived in it as your primary residence for at least 2 of the last 5 years before sale). For your specific situation, here's how the calculation works: The depreciation recapture of $75K is taxed at a flat 25% rate regardless of other factors. This is non-negotiable and separate from the rest of your calculations. For the remaining gain, you can exclude up to $500K (married filing jointly). The rental period doesn't disqualify you from the exclusion since you still meet the 2-out-of-5-year use test. So your tax calculation would be: - $75K × 25% = $18,750 (depreciation recapture) - Remaining gain: $1,425,000 - $75K = $1,350,000 - Apply exclusion: $1,350,000 - $500K = $850,000 - $850,000 × 15% (assuming that's your capital gains bracket) = $127,500 Total tax: $18,750 + $127,500 = $146,250 The temporary rental doesn't require you to prorate the exclusion since you still meet the primary residence requirements.

I went through something similar last year and found this tool that was super helpful - https://taxr.ai - it has a specific calculator for real estate transactions including depreciation recapture. I was in a similar situation (though my numbers weren't as high as yours!) with a rental period before selling, and was confused about how the 2-out-of-5 rule affected my capital gains. What I learned is that the two-year use requirement is what matters for the exclusion, not the proportion of time you rented it. The tool walks you through all the questions about improvements, depreciation, and rental periods. It even calculates the adjusted basis considering all the improvements you might have made (which can lower your taxable gain). The thing that surprised me was how the depreciation recapture worked - it's calculated separately from the rest of the gain calculation, which the tool clearly showed.

Just wanted to follow up - I decided to try https://taxr.ai after dealing with confusion about my capital gains situation. My situation was similar but with multiple properties over the years. The tool was actually really helpful for figuring out the timing requirements between sales. What surprised me was how it handled the depreciation recapture calculation. I'd been doing it wrong in my spreadsheets for years! The tool showed me that I needed to separate out the depreciation recapture portion completely before applying the exclusion. It also helped me identify some eligible home improvements I hadn't been tracking properly that increased my basis by about $45K. That alone saved me almost $7K in taxes I would have unnecessarily paid. Definitely worth the time to input all the data.

For anyone struggling to reach the IRS with questions about complex capital gains situations like this, I highly recommend using https://claimyr.com - it literally saved me weeks of frustration. I had a complicated situation with rental property depreciation and couldn't get anyone at the IRS to answer my questions. After trying for days to get through on my own (constant busy signals and disconnects), I tried Claimyr and was connected to an IRS agent in about 20 minutes. You can see how it works in this demo: https://youtu.be/_kiP6q8DX5c The agent was able to confirm exactly how my depreciation recapture would be calculated and verified that I still qualified for the full exclusion despite having rented the property. What would have taken me weeks of uncertainty was resolved in one phone call. They don't provide tax advice but can clarify how rules apply to your situation.

I have to eat crow here. After posting my skeptical comment, I was still desperate to talk to someone at the IRS about my capital gains calculation with rental depreciation, so I tried Claimyr anyway. I was honestly shocked when I got connected to an IRS representative in about 25 minutes. I've literally spent DAYS trying to get through on my own over the past few months. The agent confirmed exactly how my depreciation recapture would be handled and cleared up my confusion about the 2-out-of-5 year rule. For what it's worth, she confirmed what others have said here - the depreciation recapture is taxed separately at 25%, and as long as you meet the 2-out-of-5 year use test, you get the full exclusion amount. Saved me thousands potentially. I hate admitting when I'm wrong but in this case I definitely was.

One thing nobody has mentioned yet - are you aware of the "safe harbor" rule for properties that have been used partly as rentals? If you convert your rental property back to your primary residence for a period before selling, you might be able to minimize the tax impact. The IRS allows for "non-qualified use" to be excluded in certain situations, especially when the rental use occurs AFTER the property was your primary residence. The rules get complex, but it's worth looking into since you're in a high-value situation where even small optimizations could save tens of thousands. Also, track every single improvement you've made to the property over the years. Those all add to your basis and reduce your taxable gain.

Has anyone used TurboTax for calculating depreciation recapture and capital gains on a high-value property like this? I'm worried it might miss something with these complex calculations.

One important detail that hasn't been fully addressed - make sure you understand how the timing of your sale affects your tax situation. Since you mentioned your tenants are leaving soon and you're considering moving back in, the actual date of sale versus when you establish primary residency again can make a significant difference. Also, don't forget to factor in potential state capital gains taxes on top of the federal calculations everyone has been discussing. Some states have no capital gains tax, while others can add substantial additional tax burden on a gain this large. Given the complexity and the substantial dollar amounts involved ($146K+ in potential federal taxes), I'd strongly recommend getting a consultation with a CPA who specializes in real estate transactions before making any final decisions about timing the sale or moving back in. The cost of professional advice will be a tiny fraction of the potential tax savings you could achieve with proper planning. Have you considered a 1031 exchange if you're planning to buy another investment property? That could defer all the capital gains taxes, though it wouldn't help with the depreciation recapture portion.