IRS Publication 523
Probably the single most question I am asked, “Is the gain from the sale of my home taxable?”
Usually, the exemption is a straightforward calculation. You lived in the home for at least two years, have a gain of $250,000 or less for single or $500,000 for married taxpayers. Then you are exempt from paying tax on the sale.
If you have converted your home to rental property this calculation becomes increasingly more complex. If you have not lived in the home for two of the last five years, you are more than likely going to have to pay tax on the gain from the sale of the property. If you did live in the home, the exemption phases out for the days less than those two years reflected in the code.
All hope is not lost if selling a rental property at a gain. Buying a similar property of equal or greater value can also help you avoid paying tax on gains. This is known as a like-kind exchange or a 1031 exchange for us tax professionals. Certain rules apply such as a 45-day limit on the selection of property replacing the property sold. The subsequent sale must also take place within six months from the closing date on the previously owned property. Timing must be impeccable for a 1031 exchange.
Please consult a tax professional when this situation arises. They could save you thousands of dollars.