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Sales, Trades, Exchanges

Question: Can we move into our rental property, live there as our main home for two years, and sell it without having to pay capital gains tax?

Answer:

You may be able to exclude much of the gain from the sale of your main home that you also used for business or to produce rental income if you meet the ownership and use tests.  However, you may not exclude gain from the sale or exchange of your main home if it is allocable to periods of non-qualified use as detailed in Publication 523, Selling Your Home.

In addition, if you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you may not exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997.  If you can show by adequate records or other evidence that the depreciation deduction allowed (did deduct) was less than the amount allowable (could have deducted), you may limit the recognized gain attributable to depreciation to the amount of the depreciation allowed. For tax years beginning in 2013 or later, a simplified method of computing the deduction for the business use of a home may apply.  Please refer to Simplified Option for Home Office Deduction on our website for details.

How you report the sale of the home depends on its use in the year of the sale.

If the ownership and use tests are met and there is no business or rental use in the year of the sale, then the gain, exclusion, and depreciation-related gain that can’t be excluded should be reported on Form 8949 (PDF), Sales and other Dispositions of Capital Assets, and Schedule D (Form 1040) (PDF), Capital Gains and Losses, as described in Publication 523, Selling Your Home.

If the ownership and use tests are met but there is business or rental use in the year of sale, then the sale of the business or rental part should be reported on the Form 4797, Sales of Business Property.  Form 4797 takes the business or rental part of the gain, the exclusion, and depreciation-related gain that can’t be excluded into account.  

However, if the part of your property used for business or rental use is within your home, such as a home office for a business, you do not need to allocate gain on the sale of the property between the business or rental part of the property and the part used as a home.  In addition, you do not need to report the sale of the business or rental part on Form 4797.  This is true whether or not you were entitled to claim any depreciation.  However, you cannot exclude the part of any gain equal to any depreciation allowed or allowable after May 6, 1997.


Category: Sale or Trade of Business, Depreciation, Rentals
Subcategory: Sales, Trades, Exchanges

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The OMB number for this study is 1545-1432.
If you have any comments regarding this study, please write to:
IRS, Tax Products Coordinating Committee
SE:W:CAR:MP:T:T:SP
1111 Constitution Avenue NW
Washington, DC 20224