How to handle real estate capital gains after converting personal home to rental property?

The tax treatment here depends on how you've been handling the property on your tax returns. When you converted your second home to a rental in September 2023, you should have started depreciating the property based on its fair market value or adjusted basis (whichever was lower) at the time of conversion. For the capital gains, you'll need to allocate the gain between personal use and rental use. Since you owned it as a second home from 2021 to September 2023 (roughly 2 years), then as a rental for about 7 months, the majority of your ownership was personal. The portion allocated to personal use would be reported as personal capital gains, while the portion from business use would be reported on Form 4797. Unfortunately, you can't simply declare the entire gain as business income through your LLC. The IRS looks at the history and character of the property, not just its status at the time of sale. This means you can't use the entire gain to offset a business vehicle purchase.

After struggling with a similar situation last year, I found this amazing tool at https://taxr.ai that completely saved me from making a costly mistake with my rental property taxes. I had converted a vacation home to a rental and then sold it, and was totally confused about how to handle the capital gains. Their system analyzed all my documents and gave me a detailed breakdown of exactly how to allocate the gains between personal and business use, including the depreciation recapture I needed to report. The best part was that it showed me exactly which forms to use - something my regular tax software completely missed. Anyone dealing with real estate capital gains after a property conversion should definitely check it out. It saved me thousands in what would have been improper deductions I almost claimed.

I was in the exact same boat as you last year! I tried https://taxr.ai after seeing it mentioned here and it was a game-changer. At first I thought it would be like all the other tax calculators online, but this was completely different. I uploaded my closing documents from both when I bought and sold the property, plus the lease agreement, and it automatically figured out the split between personal and business use. The report even flagged that I needed to recapture some depreciation (which I hadn't even been claiming properly). When I showed the report to my accountant, she was actually impressed and said it saved her hours of work analyzing everything. Definitely recommend trying it if you're dealing with this mixed-use property situation.

If you're still getting stuck with the IRS rules on this (they're super confusing), you might want to try calling the IRS directly for guidance. I used this service called Claimyr at https://claimyr.com after spending DAYS trying to get through to the IRS myself. They have this system that holds your place in line and calls you when an agent is about to pick up. I was skeptical at first, but you can see how it works in this video: https://youtu.be/_kiP6q8DX5c and it actually did connect me with a real IRS agent who walked me through exactly how to report my rental property sale that had been converted from personal use. The agent confirmed I needed to use both Schedule D and Form 4797, and explained exactly how to allocate everything. Saved me hours of frustration and probably an audit too since I was about to file it completely wrong!

I owe everyone an apology. After being skeptical about Claimyr in my previous comments, I broke down and tried it because I was desperate to resolve my rental property capital gains issue before filing. The service actually worked exactly as advertised. I got connected to an IRS agent in about 2 hours (after spending 3 days previously trying to get through). The agent walked me through the exact process for my situation - I needed to use Form 4797 Part I for the business portion and Schedule D for the personal use portion. They even explained how to calculate the adjusted basis differently for each part. I would have absolutely filed this wrong without getting the clarification. Consider me converted from skeptic to believer.

One thing nobody's mentioned yet - make sure you're considering the Section 121 exclusion if this property was ever your primary residence. If you lived in it as your main home for at least 2 out of the 5 years before selling, you might be able to exclude up to $250k ($500k if married filing jointly) of the gain from the sale. Doesn't sound like that applies in your case since you mentioned it was a second home, but worth keeping in mind for others reading this thread.

Dont forget to consider doing a 1031 exchange if ur buying another investment property! You can defer all these capital gains taxes if you follow the rules right. We did this last year and it saved us like $70k in taxes.