I am active duty and lived in my home for 10 years before getting orders and having to move(having to rent the house out). The house has been under a property manager for approx 2 years (a little less). If I’m reading the tax code correctly, I’ve lived there for 2 of the past 5 years. But due to being moved short notice, we were forced to rent. The house is currently in escrow to be sold next week. Signing the documents I came across the 1099-S. Because it asks about the house being used as a rental, am I liable to report and pay taxes on the sale? Looking for any advice. Thank you.
When you rented the house it ceased to be your principal residence and became an investment property. You did meet the two year residence requirement for primary residence. Because it was converted to rental, other rules come into play involving depreciation and capital gains. You would be wise to get some expert help with preparing your tax return for the year that the house is sold.
It sounds like the property was converted to a rental 2 years ago, that would be August 2019 (more or less)?
That means that for 2019, 2020 and 2021, you need to include a schedule E for the rental with your tax return, that reports your rental income, subtracts rental expenses, and pays income tax on the net income (if you had income).
Then, when selling the home, you still qualify for the basic capital gains exclusion for meeting the 2 year/5 year rule. (And in fact, the 5 year rule can be suspended up to 10 years for service persons who are redeployed, but that does not seem to be an issue here.)
However, as part of the capital gains calculation, you will have to pay tax (depreciation recapture) on the depreciation deduction you took or could have taken on your schedule E. Then, the rest of the gain is subject to the $250,000/$500,000 exclusion. Basically, you got a deduction for depreciation while renting the home, and now that you've sold it, you have to repay that deduction. You will need to know the amount of depreciation from your 2019 and 2020 tax returns when reporting the sale on your 2021 return.