Converting Rental Property to Primary Residence

Converting rental property to primary residence is the move-back. You stop holding the house for rent and use it as your main home. The rental years before that move can keep part of a later sale’s gain from the home-sale exclusion. Depreciation allowed or allowable for periods after May 6, 1997 stays outside the exclusion as well. Moving in does not erase the rental history, and it does not step your basis up to today’s value.

This page is that tax path. It is not a mortgage for a home you plan to occupy. The opposite move, leaving a home and renting it out, is converting a primary residence to a rental. Read that page if you are moving out. The clocks run differently.

Illustrations here are not a tax return, a rate quote, or an offer of credit. Publication 523 controls the exclusion worksheet. Talk to a tax advisor for the return. An inquiry is not an approval.

Converting Rental Property to Primary Residence and the Exclusion

Publication 523 explains the exclusion of gain on the sale of a main home. The maximum is $250,000, or $500,000 if you are married filing jointly, and only if you meet the tests. You must have owned the home for at least 24 months of the 5 years before the sale. You must have used it as your residence for at least 24 months of those 5 years. The publication also describes those 24 months as 730 days. The months need not be one continuous block. For a joint return, only one spouse must meet the ownership test. Each spouse must meet the residence test to claim the full $500,000. You can use the exclusion only once in a 2-year period.

Those tests still apply when the house used to be a rental. Living there for 4 years after a long rental stretch can satisfy the 24-month use test. It does not make the earlier rental years disappear.

Publication 523 calls the problem nonqualified use. Gain allocable to periods of nonqualified use is not excludable. Nonqualified use is a period after 2008 when neither you nor your spouse used the property as a main home, with exceptions the publication lists. One exception does most of the work for someone who lived in the house first and rented it later: time in the 5-year period ending on the sale that falls after the last date the property was your main home is not nonqualified use. That exception is the other article’s direction.

It does not help the move-back. Publication 523’s example of renting first and moving in later allocates part of the gain to the earlier rental period. Worksheet 3 is the one to run before you assume the full $250,000 or $500,000 is available. A reduced exclusion can exist when you fail the full test for specific reasons the publication lists, such as certain work, health, or unforeseen circumstances. That reduction is its own worksheet. Do not invent the fraction.

A Move-Back Illustration

Count a house owned for 10 years, 3,650 days in this illustration, ignoring leap days. You rented it for the first 6 years, 2,190 days, all after 2008, and it was not your main home in those years. You then lived in it for 4 years, 1,460 days, and you sell while that use is still inside the lookback. The nonqualified-use fraction on the gain that remains after ineligible depreciation is 2,190 divided by 3,650, or 60 percent.

Illustration line	Amount
Amount realized	$500,000
Adjusted basis	$300,000
Total gain	$200,000
Depreciation after May 6, 1997, not excludable	$40,000
Gain remaining	$160,000
60 percent nonqualified use	$96,000
Gain left to test against the exclusion	$64,000

In this illustration the $64,000 is under the $250,000 maximum. If the ownership and use tests are met, that $64,000 can be excluded. The taxable piece is the $40,000 of depreciation plus the $96,000 allocated to the rental years, $136,000. Your preparer follows the current Publication 523 worksheet, which controls if the line order differs. The point of the illustration is the direction: the years you rented before you moved in stay in the numerator. A longer residence after the move shrinks the fraction. It does not set the fraction to zero.

Depreciation is pulled out because the exclusion does not cover gain equal to depreciation allowed or allowable after May 6, 1997. Depreciation recapture on a rental is that slice. Skipping a year you were allowed to claim does not keep the gain inside the exclusion. How depreciation works on a rental is why the basis fell in the first place.

If you lived there only 18 months before the sale, you have not met the 24-month residence test. The nonqualified-use math does not replace that test. A partial exclusion, if a listed reason applies, is the publication’s separate worksheet.

One more clock sits on houses acquired in a like-kind exchange. Publication 523 applies a five-year ownership period before the exclusion is available when the home was acquired in a section 1031 exchange. The 24-month use test does not shorten those five years. Confirm the acquisition date with your advisor before you treat a 1031 replacement as a normal move-back.

The Year You Move In

You stop depreciating the house when you retire it from rental use. Publication 527 is the rental-property publication the companion article uses for the placed-in-service rules. Those rules run backward here. The years you live in the house as your home are not depreciable. Basis does not reset because you moved in. Adjusted basis carries, including depreciation you took or were allowed to take. There is no step-up to market on a conversion to personal use. Cost basis is the record to keep through the move.

If you rented the house for part of the year and then moved in, that year’s deductions can be limited by the personal-use day tests. Personal use of a rental property is that limit. A move-back is a change of use. A two-week stay while it was still held out for rent is the other article. Do not use one test for both facts.

If you later move out and rent the house again, you are back in the primary-to-rental conversion, including the lesser-of basis rule for a new placed-in-service date. Do not assume this page’s exclusion math freezes a second time.

The policy should change with the use. A landlord form is the wrong form once you occupy the house as your home. Landlord insurance versus a homeowners policy is the comparison from the rental side. Revisit it when you move back, with the insurer, before a claim teaches you which form was in force.

The Loan You Already Have

A business-purpose loan on a rental is underwritten as non-owner-occupied. Moving in can conflict with that occupancy term even when the payment is current. Read the note and talk to the servicer before you change use. This site does not offer a mortgage for a primary residence. Whether a DSCR loan can be owner-occupied is the occupancy question on that product. It does not set your exclusion, your basis, or your depreciation stop date.

Capital gains on a rental sale is the backdrop if you sell without meeting the residence tests at all. The move-back is a way the exclusion can cover part of the gain. It is not a way to shelter the rental-period depreciation, and it is not a way to shelter the fraction of gain Publication 523 allocates to the years you rented first.

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Frequently Asked Questions

Does moving back in erase the rental years?

No. Converting rental property to primary residence leaves those earlier years inside the nonqualified-use fraction if they fall after 2008 and the home was not your main home then. Publication 523 allocates gain to that period. Time you live there after the move can satisfy the residence test and can shrink the fraction. It does not delete the numerator.

Do I still need two years of residence?

Yes, for the full exclusion. Publication 523 requires 24 months of ownership and 24 months of residence in the 5 years before the sale. A rental history does not replace either test. A reduced exclusion for specific reasons is a different worksheet in the same publication. Do not estimate it from the 60 percent illustration on this page.

What happens to depreciation when I move in?

You stop depreciating when the house is no longer held for rent. Basis stays at adjusted basis, including depreciation allowed or allowable. Gain equal to depreciation after May 6, 1997 is not eligible for the home-sale exclusion, even when the rest of the qualified-use gain is. Moving in is not a step-up.

What if I acquired the house in a 1031 exchange?

Publication 523 applies a five-year ownership period before the exclusion is available on a home acquired in a like-kind exchange. Meeting the 24-month use test inside those five years is not enough. Your advisor should match the acquisition date on the exchange to the sale date before you plan the move-back around the exclusion.

Is this a mortgage for a home I will live in?

No. The subject is the tax path when a rental becomes your main home: nonqualified use, depreciation, and the day depreciation stops. A business-purpose loan may restrict owner occupancy. This page does not offer primary-residence financing.