Capital gains from selling a house where lived in and rented out

[Mango-muncher]

When selling a house where you have lived in it less than 2 years, and rented it out for several years subsequently, how can you best avoid capital gains tax? Is there anything other than taking partial exclusions that you can do? When pay the capital gains tax - at time of sale or April 15?

[SwapnaM]

Did you already sell the house or planning to sell? To qualify for the full exclusion, you must meet both the ownership test and the use test:

• You must have owned the home for at least 2 out of the 5 years leading up to the sale.

• You must have used the home as your main home for at least 2 out of the 5 years leading up to the sale.

In your case, you lived in it for less than 2 years initially, and then rented it out for several years. This means you will likely NOT qualify for the full exclusion.

Even if you qualify for the exclusion, depreciation claimed during rental years is always taxable at a maximum rate of 25%. This is called depreciation recapture and cannot be excluded under Section 121.

If you haven't sold the house, consider moving back in & use it for personal use for 2years to get the full exclusion.  If you have other investments in taxable accounts, consider selling any investments at a loss in the same tax year as the home sale. Capital losses can offset capital gains, and then up to $3,000 of ordinary income annually.

You report the gain on your tax return for the year of the sale (e.g., if sold in 2025, report on your 2025 return due April 15, 2026). If you expect a large gain, consider making estimated tax payments to avoid underpayment penalties.

@Mango-muncher Thanks for the question!! Hope this helps!