So my parents purchased this house in 1996. We lived in it until 2011.
I assume "we" refers to you and your parents.
In 2011, I purchased the property from my parents.
Thus making your the sole owner of the property.
My parents used the money to fix up the house
Just so I'm clear. The parents used the money you paid them for the house, to fix up a house that you own, and they don't own.
and we put it up for rent.
So now is "we" you and your spouse? I will assume so. Can't be you and your parents, assuming they have no ownership rights to the house.
It has been a rental property since 2011. I just sold this house in Dec 1, 2020.
If you sold the house at a gain, meaning more than what you paid your parents for it, you "will" pay taxes on any realized gain, as well as on the depreciation you are required to recapture. Period.
My husband and I are planning to use the money gained from the sale to build a new home.
What you do with the money realized from the sale does not matter. The gain realized from the sale is taxable income. No way around it, since you did not live in the house as your primary residence for at least 2 of the last 5 years you owned it.
Does anyone know if a) can i avoid capital gains tax by qualifying for this to have been a residence for me?
Basically, if the house was you *PRIMARY* residence for at least 2 of the last 5 years you owned it, then you can exclude up to $250,000 ($500,000 if filing joint) from your taxable income. But as I interpret your post, the house was "NEVER" your primary residence at any time during the last 5 years you owned it. Therefore, you don't qualify for *any* capital gains tax exclusion, unfortunately.
I would suggest you hold back no less than 20% of the gain for taxes. If your state taxes personal income you'll need to hold back to cover state taxes too.
On a positive note, the property improvements paid for by your parents with "their" money (what you paid them for the property) increases the cost basis of the property for "you". That will help reduce your taxable gain.
