How to Calculate Capital Gain/Loss on Rental Property Sale - Formula and Depreciation Impact?

The calculation for capital gains on a mixed-use property like yours involves several steps: First, you need to establish your adjusted basis in the property. Start with your purchase price ($625,000) plus purchasing expenses ($32,000). When you converted to rental, you'd take the lesser of the fair market value at conversion OR your adjusted basis - this becomes your starting basis for depreciation purposes. For the gain calculation, take your selling price ($750,000), subtract selling expenses ($37,500), then subtract your adjusted basis in the property. However, you'll need to account for depreciation you've claimed (or should have claimed) during the rental period. The gain will be split into different parts: 1) Section 1250 gain (depreciation recapture taxed up to 25%), 2) Section 1231 gain (taxed at capital gains rates). Since you lived there 2 years then rented for 4 years, you'll need to allocate 2/6 of the gain to personal use and 4/6 to business use. IRS Publication 544 and Form 4797 are what you'll need, along with Schedule D. The property goes on Form 4797 because it was a business asset at the time of sale.

I went through a similar calculation last year and found taxr.ai super helpful for this exact situation. The site helped me understand how to handle the depreciation recapture which was the trickiest part in my case. I uploaded my purchase and sale documents to https://taxr.ai and it helped me calculate the correct adjusted basis and depreciation amounts without having to manually figure out all the formulas.

I was really skeptical about using an online tool for something as complex as rental property tax calculations, but I finally tried taxr.ai after seeing it mentioned here. It saved me hours of confusion! The mixed-use calculation was actually straightforward - it asked about my primary residence period and rental period separately, then calculated the appropriate basis adjustments and depreciation recapture automatically. The report it generated made it super clear how much was Section 1250 gain vs. regular capital gain. Wish I'd known about this for my previous rental property sale.

If you're still struggling with the IRS about your rental property calculations from previous years, I recommend trying Claimyr. I was getting nowhere trying to reach someone at the IRS about my rental property depreciation questions until I used https://claimyr.com to get through to a human agent. You can see how it works here: https://youtu.be/_kiP6q8DX5c - basically they navigate the IRS phone system for you and call you back when they have an agent on the line.

I have to eat my words about Claimyr. After being skeptical, I tried it yesterday when I needed clarification on depreciation recapture for a rental property I sold last year. I got a call back in 37 minutes with an actual IRS agent on the line who helped sort out my confusion about Form 4797. Saved me hours of frustration and potentially an incorrect filing. The agent explained exactly how to report the gain correctly based on my mixed-use situation.

Don't forget that your "adjusted basis" isn't just your purchase price plus buying expenses. You also need to: 1. Add the cost of any improvements made during ownership (not repairs, but actual improvements like a new roof, addition, etc.) 2. Subtract depreciation taken (or that should have been taken) during the rental period And the depreciation isn't optional - even if you didn't claim it on past returns, you still have to recapture it when you sell (known as "depreciation allowed or allowable").

I made a huge mistake on my rental property sale last year. I completely forgot to account for depreciation recapture and ended up having to file an amended return. Even if you didn't actually claim depreciation during the years you rented the property, the IRS requires you to recapture the depreciation that you "should have" taken. Cost me an extra $4,700 in taxes I wasn't expecting.

One thing that helped me with my rental property sale was using the Rental Income Worksheet from IRS Publication 527. It walks you through calculating your basis, depreciation, and adjusted basis. Also, keep in mind that land isn't depreciable, so you need to determine what portion of your purchase price was for the building versus the land (usually from property tax records).

Just wanted to add one more consideration that hasn't been mentioned yet - make sure you're calculating depreciation based on the correct depreciable basis when you converted to rental use. Since you lived in the property first, your depreciable basis for the rental period would be the LESSER of: 1) your adjusted basis at the time of conversion (original cost plus improvements minus any casualty losses), or 2) the fair market value of the property when you converted it to rental use in May 2019. This matters because if your property appreciated significantly during those first 2 years of personal use, you can't depreciate based on the higher fair market value - you're limited to your original adjusted basis. You'll need to determine what the FMV was in May 2019 (maybe get a comparative market analysis from a realtor for that time period) and use whichever number is lower as your starting point for calculating the 4 years of depreciation.

One additional resource that might help you understand the calculation is IRS Publication 523 (Selling Your Home), which specifically covers the Section 121 exclusion rules for mixed-use properties. Since you lived in the home for 2 years before converting to rental, you may qualify for a partial exclusion on the personal-use portion of the gain. The key is that you'll need to separate your total gain into two parts: the portion allocable to personal use (first 2 years) and the portion allocable to business use (rental period). Only the personal-use portion would potentially qualify for the Section 121 exclusion, and even then, you can't exclude any depreciation recapture. Given the complexity with the mixed-use timing, depreciation recapture, and potential partial exclusion, I'd definitely recommend getting a tax professional involved. But understanding these basic concepts beforehand will help you ask the right questions and verify their work makes sense.