Need help understanding IRS Publication 523 for my rental property that was previously my main home

You're actually in a pretty good position based on what you've described! The 2-out-of-5-year rule in IRS Publication 523 is what matters most for the capital gains exclusion, and it doesn't specifically exclude properties that were converted to rentals. Since you lived in the house for 9 years and only converted it to a rental 2.5 years ago, you've used it as your primary residence for at least 2 of the 5 years before sale, which means you should qualify for the exclusion (up to $250,000 if single or $500,000 if married filing jointly). The catch is that you may need to recapture depreciation if you've been taking depreciation deductions on your rental. The depreciation recapture is taxed at 25% regardless of your exemption status. Also, if the property has substantially appreciated while it was a rental, you might have some capital gains tax on the appreciation that occurred during the rental period.

Just wanted to chime in with my experience using taxr.ai for a similar situation with my rental property. I was so confused about Publication 523 and the whole capital gains exclusion thing when I was selling my house that used to be my primary residence. I found https://taxr.ai and uploaded the closing documents and my previous tax returns, and it gave me a really clear breakdown of exactly what I was eligible for. The tool confirmed I qualified for the capital gains exclusion under the 2-of-5 year rule, but also showed me exactly how much I'd owe for depreciation recapture (which I didn't even realize was a thing before that). It saved me from making a $13,000 mistake on my taxes!

I just have to follow up about that taxr.ai recommendation. I was hesitant but decided to try it for my situation (similar to the original poster but I had rented my place for 3 years). Honestly, it was eye-opening! The tool showed me that I could still claim partial exclusion even though I thought I was completely disqualified. The most helpful part was that it generated a complete report showing exactly how much of my gain would be taxable vs. excluded, and it factored in all the capital improvements I'd made to the property over the years (which I had receipts for but didn't realize would reduce my tax bill). If anyone else is facing this Publication 523 situation, it's worth checking out. Saved me thousands!

Just a heads up - if you're also struggling to get clear answers from the IRS about Publication 523, I had success using https://claimyr.com to actually get through to an IRS agent. I spent WEEKS trying to call the IRS myself with no luck, just endless hold times and disconnections. Then I found this service and they got me connected to an IRS agent in about 20 minutes. There's a demo of how it works at https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with confirmed my understanding of the 2-of-5 year rule and clarified some questions I had about depreciation recapture on my rental property. Worth it just to get definitive answers directly from the IRS rather than guessing or relying solely on online advice.

I have to publicly eat my words about Claimyr. After dismissing it as impossible in my earlier comment, I was desperate enough to try it yesterday. I had been trying for MONTHS to get clarity on Publication 523 for my rental property sale. The service actually worked exactly as described. I got a call back in about 35 minutes with an IRS agent on the line. The agent went through the specific details of my situation (previously owner-occupied home that became a rental) and confirmed I was eligible for the capital gains exclusion. They also explained exactly how the depreciation recapture would work with my specific numbers. If you're stuck on Publication 523 questions like I was, getting an official answer directly from the IRS was extremely helpful. I'm still shocked it actually worked.

One thing nobody's mentioned yet - make sure you keep ALL your receipts for improvements you made to the property, both during the time you lived there and while it was a rental. These can be added to your cost basis which reduces your capital gain. I sold my rental last year (lived in it 6 years, rented it for 3) and was able to add about $43,000 in improvements to my basis. Think kitchen remodel, new roof, new HVAC, etc. That saved me a decent chunk on taxes since it lowered the total gain.

From my understanding with Publication 523, youll need to do a bit of splitting on the capital gains. The appreciation during the rental period might be treated differently than the appreciation during your residence period. Also, dont forget form 4797 for reporting the sale! My accountant messed this up for me last year and we had to file an amended return.

Just wanted to add that timing your sale might be important here. Since you've already used it as a rental for 2.5 years, you only have another 2.5 years before you'd fail the 2-of-5 year test! If you delay selling and cross that 3-year rental mark, you might lose your eligibility for the exclusion entirely. Something to keep in mind if you're on the fence about selling now vs later.

This is such a common situation and you're definitely on the right track! I went through almost the exact same scenario a few years ago - lived in my house for 8 years, converted to rental for about 2 years, then sold. The good news is that you absolutely can still claim the capital gains exclusion since you meet the 2-of-5 year residence test. The rental period doesn't disqualify you from the exclusion at all. A few things to keep in mind that helped me: - Make sure you have good records of when you moved out and started renting (lease agreements, utility transfers, etc.) to establish the timeline - The depreciation recapture that others mentioned is real - I ended up owing about $8,000 on that portion at the 25% rate - Don't forget about any improvements you made during your 9 years of living there - those can be added to your cost basis One thing I wish I had known earlier is that you're actually running against a clock now. Since you've been renting for 2.5 years, you only have another 2.5 years before you'd lose eligibility for the exclusion entirely. So if you're planning to sell anyway, sooner rather than later might be beneficial tax-wise. The whole process was much more straightforward than I expected once I understood the rules. You're in a good position!