Capital gains in 2 states on a house that was our primary residence and then became a rental property

[fancyfitz]

We are selling a home in California that was our primary residence for 12 years; we have been renting out the home for the last 2 years, since we had to relocate to Massachusetts. 

We lived in the house for 2 of the last 5 years, so we should qualify for the $500k exemption on capital gains.  But because it was a rental for the last 2 years, how much of the sale of the home would qualify for the $500k capital gains exemption for joint filers?

And how would the rest of the gains be taxed, seeing as how the property is in California but we are in Massachusetts?

[Coleen3 · Accepted solution]

You will have to recapture the depreciation that was taken during the time it was a rental. It will be taxed as ordinary income.There is no way to avoid this. You may next deduct the $500K. If there is any gain left, after these two factors are taken into account, they will receive capital gain treatment.

[Zbucklyo]

The transaction will be taxed by CA, so you will file a CA non-resident return, and pay CA taxes on the depreciation recapture (taxed as ordinary income, but with a 25% cap for federal purposes).  If there is a capital gain after the 500K exclusion, it will also be taxed by CA.  You will then get a credit on your MA return for taxes paid to CA (you should complete the CA return first), but this effectively means this portion of your income will be taxed at the higher CA tax rate.