Tax implications when selling a rental property that was previously my primary residence?

Thank you for the detailed explanation. So if I understand correctly, as long as I sell within 5 years of moving out, I could still use the primary residence exclusion? Also, I'm confused about depreciation recapture - do I pay that even if I don't claim depreciation on my taxes?

Yes, that's right - as long as you sell within 5 years of moving out, you can still qualify for the exclusion, assuming you meet the 2-year ownership and use test, which you would based on your 5 years of living there. Regarding depreciation, it's not optional - you're required to take it on rental property even if you don't claim it on your tax returns. The IRS will calculate "allowed or allowable" depreciation when you sell, so you'll face depreciation recapture tax on that amount regardless. This is why it's important to actually claim the depreciation while you're renting the property out, since you'll be taxed as if you did anyway.

Sounds useful but how exactly does it work? Do you upload all your documents and then what? Does it give you actual tax forms or just tell you what to put where? My situation is kind of complicated because I've made some improvements to my property while renting it out.

Did a human review your situation or is it all automated? I've been burned by "AI tax tools" before that missed important details. Also, was your original purchase before or after 2018? My tax guy says the rules changed.

You upload your closing statements from both purchase and sale, plus any documentation for improvements you've made to the property. It analyzes everything and gives you a detailed report showing exactly how to calculate your basis, what portion of gain is eligible for exclusion, and what will be subject to capital gains. For improvements made during the rental period, it shows how to add those to your basis. It's a combination of AI analysis and human review. A tax professional actually reviews your documents and the AI-generated analysis to make sure nothing is missed. My purchase was in 2016, but the system handles properties purchased both before and after the 2018 changes. The tax law changes mostly affected mortgage interest deductions rather than capital gains on sale, but they cover all the relevant rules.

Wait, so some company calls the IRS for you? How does that even work? Doesn't the IRS need to verify your identity before discussing your tax info? Seems fishy to me.

Yeah right. The IRS won't even answer their phones half the time. I've been trying to get through for 2 months about my rental property issue. If this actually worked, everyone would be using it. Sounds like you're just promoting some scam.

They don't talk to the IRS about your specific tax information - they simply wait on hold for you. When an IRS representative finally picks up, you get a call connecting you directly to that person. At that point, you're the one speaking with the IRS agent and verifying your identity. It's completely legitimate and well-known. I was skeptical too, but it works exactly as advertised. The IRS absolutely will answer their phones, but the wait times can be insane - 2-3 hours is common, especially during tax season. This service just handles the hold time for you so you're not stuck with a phone glued to your ear all day. They're essentially a "hold your place in line" service, not someone pretending to be you.

Thanks for bringing up state taxes - I hadn't even considered that! For the 1031 exchange, I thought those were only for investment properties? Since I'm planning to use the money to buy a new primary residence, would that still qualify?

You're right about the 1031 exchange - that only works if you're exchanging one investment property for another investment property. Since you're planning to use the proceeds for a primary residence, that wouldn't qualify. The primary residence exclusion (Section 121) is likely your best bet here. Just be aware of your state's specific rules since they don't always align with federal treatment. Some states are more restrictive about the exclusion for properties that were converted to rentals.

I used TurboTax last year for almost this exact scenario. It worked fine but you need to be VERY careful answering all the questions about dates when it was your primary residence vs rental. The software does the calculations correctly if you input everything properly, but it's easy to make a mistake. The depreciation recapture part was a bit confusing, and I almost entered something wrong. If your gain is substantial or your situation has any complexity (like major improvements), might be worth consulting a pro at least for a review.

This is excellent advice! I wish I had known about getting a professional appraisal when converting to rental - I just used online estimates which probably won't hold up well if questioned. The documentation point is so important too. I'm already renting out my former primary residence and I've been pretty sloppy with record keeping. Time to get organized before I sell! Do you know if there's a specific timeframe the IRS looks at for establishing fair market value at conversion, or is it just "around the time" you start renting?

The IRS doesn't specify an exact timeframe, but they generally expect the fair market value to be determined "as of the date of conversion to rental use." In practice, this means within a reasonable period around when you actually start renting it out - typically within 30-60 days is considered acceptable. If you're already renting and haven't established this value yet, you can still get a retroactive appraisal, but make sure the appraiser specifically dates it to when you converted the property. Some appraisers will do "retrospective appraisals" that establish value as of a past date, which can be helpful in your situation. For record keeping going forward, I'd suggest creating a simple spreadsheet or folder system to track: rental income, all expenses (repairs, maintenance, property management, etc.), any improvements (keep receipts!), and correspondence with tenants. The better your documentation, the smoother things will go when you eventually sell.

This is such a crucial point about the timing! I hadn't really thought about what happens if the sale gets delayed beyond that 5-year window. That could be a really expensive mistake if you suddenly lose the $250k/$500k exclusion eligibility. Your point about running the actual numbers is spot on too. Between property management headaches, potential repairs, vacancy periods, and now all this tax complexity, the rental income might not be as attractive as it initially seemed. Plus if you're moving for a new job, do you really want to be dealing with tenant issues from a distance? Maybe it would be worth getting quotes from a few real estate agents to see what the current market looks like for selling now versus trying to time it perfectly in 2 years. Sometimes the simplest path is the best one!

Thank you so much for the professional perspective! This is exactly the kind of expert guidance I was hoping to get. A couple of follow-up questions if you don't mind: 1. When you mention that depreciation recapture applies at 25% even with the Section 121 exclusion - does that mean I'd be paying 25% tax on whatever depreciation I'm required to claim during the rental period, regardless of whether the overall gain qualifies for exclusion? 2. For someone in my situation who's still in the planning phase, would you recommend getting a consultation before I even move out and start renting? It sounds like there might be some strategic decisions to make upfront that could affect the tax outcome later. I'm really starting to lean toward just selling now after reading everyone's responses. The potential tax savings from renting it out for 2 years might not be worth the complexity and risks, especially if I mess up the timing or documentation requirements.