Written by Randall Weaver, CPA & Alex Mowery, CPA
Are you thinking about moving into your rental property to save on taxes when you sell? You’re not alone; many property owners explore this idea to take advantage of the home sale gain exclusion. But the rules are trickier than they seem, and depending on your history with the property, the savings might not be as big as you’d expect.
Here’s a plain English breakdown of what you need to know:
The IRS lets you exclude up to $250,000 ($500,000 for married couples) of profit when you sell your home if:
This sounds great, but...
If the home was a rental for a long time, the story changes. The IRS sees that time as “nonqualified use,” meaning you can’t exclude that part of the gain. So even if you move in now and live there for 2 years, you might only get a small tax break.
Here’s an example:
Only 2 out of 17 years were as your main home, so just 12% of the gain qualifies for the tax break. The remaining 88% is fully taxable.
The IRS gives you a break if you first lived in the home and then rented it out within the final 5 years.
Example Where Full Exclusion Still Applies:
Since the rental time falls after your period of personal residence (and within the 5-year window), you still qualify for the full exclusion.
If you rented the property and claimed (or could have claimed) depreciation, the IRS will tax that depreciation when you sell. This is called depreciation recapture, and it's typically taxed at up to 25%.
Learn more in our post on Depreciation Recapture.
If you have passive activity losses from the rental, those won't be released when you sell if you qualify for any gain exclusion under §121. Why? Because to release those losses, the sale must be fully taxable, and the exclusion makes it only partially taxable.
The losses aren’t gone forever, but you’ll need future passive income to use them.
Here’s what happened in one scenario we reviewed:
So, while the home sale exclusion can be powerful, it’s not a magic bullet, especially if your property was a rental first. Before you move back in, it’s worth running the numbers with a tax professional.
At Trout CPA, we specialize in helping real estate investors make smart tax decisions. Whether you’re selling a long-held rental or planning your next purchase, our team is here to help you navigate the complexities and maximize your tax outcomes.
Randall Weaver, CPA
Randall joined Trout CPA in 2011. He graduated from Millersville University with a Bachelor of Science degree in Business Administration (magna cum laude) in 2006. Randall has over 19 years of accounting experience. He currently serves on the firm's Construction and Real Estate, Manufacturing, and Estate & Trust Practice Groups. As a Partner, Randall manages all aspects of tax planning and preparation and business consulting for some of the firm's significant clients. Randall enjoys activities with his family, being involved with his church, and rooting for Philadelphia sports teams. He lives in Lancaster County with his wife and two children.
Alex Mowery, CPA
Alex joined Trout CPA in June 2022 after working with the firm for the previous three tax seasons. He graduated Summa Cum Laude from West Chester with a Bachelor of Science degree in accounting and a minor in White Collar Crime. He took an accelerated course load and completed the 150 credits required to become a CPA in two years of study. As a Senior Associate, Alex handles various aspects of tax planning and preparation at the corporate and individual levels. In his free time, Alex enjoys spending time with family and friends and playing recreational sports. He lives in Lancaster County.