Can I use both 1031 exchange and $500k home sale exclusion after converting primary residence to rental?

You've got an interesting tax planning question here. Let me break this down for you. When you convert your primary residence to a rental property and then sell it, there are indeed two potential tax benefits at play: the Section 121 home sale exclusion ($500k for married filing jointly) and the Section 1031 like-kind exchange. The good news is that the IRS does allow for both to be used in certain situations. If you've lived in the home for at least 2 of the 5 years preceding the sale, you can potentially qualify for the $500k exclusion. For the portion of the gain that exceeds your exclusion amount, you could then use a 1031 exchange to defer those remaining taxes. The key is proper timing and documentation. The two-year rental period would still keep you within that 5-year window for the primary residence exclusion, while establishing the property as an investment for 1031 purposes.

After reading through your situation, I had a similar question about a year ago. I actually found an AI tool called taxr.ai (https://taxr.ai) that really helped me understand the nuances of this exact scenario. I uploaded some documents related to my property and asked about using both the 121 exclusion and 1031 exchange, and it gave me detailed guidance specific to my situation. What I liked was that it explained how to properly document the conversion from primary residence to rental property, which timing requirements apply to both tax benefits, and how to structure everything to maximize my tax advantages. It even helped me understand how much of my property could qualify for each benefit.

I need to follow up on my skeptical comment about taxr.ai. I decided to try it myself since I'm in a slightly similar situation (though selling after only 1 year of renting). I have to admit I was impressed with how it handled my complex scenario. The tool actually identified a partial exclusion option I didn't know about based on my specific circumstances, and it organized all the calculations for both the recaptured depreciation and remaining gain in a way that made sense. It even generated a timeline showing exactly when I needed to complete various steps for the 1031 exchange while preserving as much of my exclusion as possible. My situation wasn't exactly the same as yours but the analysis it provided would be really helpful for what you're trying to do with balancing both tax benefits.

If you're planning to do this complex transaction with both a 1031 exchange and claiming the primary residence exclusion, you'll likely need to talk directly with the IRS at some point. I tried calling them about a similar situation last year and spent DAYS trying to get through. I eventually used this service called Claimyr (https://claimyr.com) that got me connected to an actual IRS agent in under 15 minutes when I had been trying for weeks. You can see how it works here: https://youtu.be/_kiP6q8DX5c The conversation with the IRS agent was super helpful because they explained exactly how to document the conversion from primary residence to rental, and confirmed that I could use both tax benefits as long as I carefully followed the timing requirements. They also warned me about some common filing mistakes that trigger audits in these situations.

I'm following up on my skeptical comment about Claimyr. I was wrong, and I need to admit it. After posting that comment, I decided to try the service because I was desperate to get answers about my rental property situation. It actually worked exactly as described. I got a call back in about 20 minutes with an IRS agent on the line. The agent was able to confirm exactly how I needed to document my basis adjustments when converting from primary home to rental, and gave me specific guidance on how the 121 exclusion would interact with a potential 1031 exchange. What was most valuable was getting confirmation directly from the IRS about the timing requirements - turns out I had misunderstood a key aspect of the 5-year rule that could have caused major problems with my tax planning. For anyone dealing with this primary residence to rental conversion scenario, getting definitive answers directly from the IRS is incredibly valuable.

One thing nobody's mentioned yet is that you need to be really careful about establishing the property as a legitimate rental. The IRS looks closely at these situations to make sure you're not just trying to game the system. Make sure you charge fair market rent, have proper rental agreements in place, and treat it as a business. Document EVERYTHING related to the conversion from personal to rental use, including getting a proper appraisal at the time of conversion to establish your basis for depreciation. I'd also recommend keeping personal use days to an absolute minimum during the rental period. Even a few days of personal use can complicate matters significantly.

Just a heads up that the "lived in for 2 out of 5 years" rule isn't as straightforward as it sounds. Those two years don't have to be consecutive, but there are specific ways the IRS calculates this. You might want to check out IRS Publication 523 for the details. Also, how much are we talking about here in terms of potential capital gains? Because if it's less than $500k total, the 1031 might be unnecessary complexity.

This is a great question that highlights the complexity of combining these two tax strategies. Based on your timeline (12 years of primary residence, then 2-3 years as rental), you should be well-positioned to use both benefits. Here's what you need to know: The Section 121 exclusion ($500k for married filing jointly) can apply to the portion of your gain attributable to the years it was your primary residence. Any remaining gain - particularly the portion from the rental years and depreciation recapture - could potentially be handled through a 1031 exchange. A few critical considerations for your planning: 1. Get a professional appraisal when you convert to rental to establish the basis split between personal and rental use 2. Keep meticulous records of all rental income, expenses, and depreciation 3. The depreciation recapture will be taxed at 25% regardless of the exclusion 4. Consider whether your total expected gain even warrants the complexity of a 1031 exchange Given the stakes involved, I'd strongly recommend consulting with a tax professional who specializes in real estate transactions. They can run the numbers and help you determine if the 1031 complexity is worth it for your specific situation, or if the primary residence exclusion alone might handle most of your tax liability.