Retirement Literacy Foundation · Seller Tax Education

Converting a Rental to a Primary Residence, or a Home to a Rental

By Hans Goldstein, founder, Retirement Literacy Foundation · Updated October 8, 2026

Short answer: The home sale exclusion (IRC section 121) lets you exclude up to $250,000 of gain ($500,000 married filing jointly) if you owned and lived in the home for 2 of the 5 years before the sale. Converting a rental into your home can earn part of that exclusion, but rental years after 2008 reduce it, depreciation is still taxed, and a home acquired in a 1031 exchange must be held 5 years first.

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Rental first, then your home

You need 2 years of ownership and use as your main home within the 5 years before the sale.
Nonqualified use: years after 2008 when it was a rental (before you moved in) reduce the exclusion proportionally. Example: 10 years of ownership with 6 rental years after 2008 means only 40% of the gain can be excluded.
Depreciation taken after May 6, 1997 cannot be excluded; it is taxed as unrecaptured section 1250 gain.
From a 1031 exchange: if the home was acquired in a like-kind exchange, you must hold it at least 5 years before the exclusion is available (IRC 121(d)(10)).

Your home first, then a rental

Renting it out after you move out does not count as nonqualified use if you sell within the 5-year window, so you can rent for up to 3 years and still exclude the full gain (other than depreciation).
After 3 years of renting, you fail the 2-out-of-5-years test and lose the exclusion.
A former home that is now a rental can sometimes use both section 121 and a 1031 exchange on the same sale (Rev. Proc. 2005-14): exclude up to the limit and exchange the rest.

Planning points

Track the dates you moved in and out and any depreciation claimed.
A large remaining gain above the exclusion can still be spread with an installment sale. See selling a home with a large gain.
Selling the year after a spouse dies: a surviving spouse can still use the $500,000 exclusion if the sale is within 2 years of the death.

Common questions

Can I move into my rental property to avoid capital gains tax?

Partly. Living there 2 of 5 years lets you claim the exclusion, but rental years after 2008 reduce it proportionally and depreciation is still taxed.

How long must I live in a 1031 property before selling it tax-free?

You must own it at least 5 years from the 1031 exchange, and live in it as your main home for at least 2 of the 5 years before the sale.

Can I do a 1031 exchange on my former home?

If it has become a rental or investment property, yes, and you may be able to combine the home sale exclusion with a 1031 exchange on the same sale.

More for sellers: Suspended Passive Losses When You Sell a Rental Property · Capital Loss Carryover · Real Estate Professional Status Explained · Unrecaptured Section 1250 Gain Explained · QSBS

Education only; nothing is sold here. The Retirement Literacy Foundation is a 501(c)(3) nonprofit. Tax rules depend on your facts; check with a CPA or tax attorney before you sell.