I bought my home during the real estate bubble in 2006. The purchase price was $335,000. It was my primary residence. During the crash it lost more than 50% of it's value within two years. In 2015 I decided to move to another city, but because my mortgage was still underwater, I could not sell it. It was worth about $175,000 at that time. I rented it out for a little over two years, and after that period it was then worth about $240,000. (Then I kept it empty for a 6 months while getting ready to sell it.) I am now selling the home for $270,000. This price is $65k less than the purchase price that I bought it for. But will the IRS say that I have to pay a capital gain (business gain) for the value it acquired back while I used it as a rental?
During 2 years of rental, you did or were entitled to take depreciation based on the lower of your cost basis or the FMV at the time. 2 years of depreciation based on an FMV of $175,000 is about $13,000. That reduces your cost basis for the sale to $322,000. Since you sold for less than your adjusted cost basis, you don't owe capital gains tax or depreciation recapture tax.