How do I report the sale of a rental property that qualifies for the main home exclusion?

If you sold a property that was used as both your main home and a rental property, you may be eligible for the home sale exclusion while still being required to report the rental portion of the property separately.

In general, the IRS allows you to exclude gain from the sale of your main home if you meet the ownership and use requirements.

Do I Qualify for the Main Home Exclusion?

The IRS ownership and use tests generally require that:
  • You owned the property for at least 2 years during the 5-year period ending on the date of sale, and
  • You used the property as your principal residence for at least 2 years during that same 5-year period.

If you meet these requirements, you may qualify for the home sale exclusion, even if the property was rented for part of the time.

You may also qualify for a partial exclusion in certain situations involving:

  • Job-related moves
  • Health-related reasons
  • Certain unforeseen circumstances

Do I Need Both Form 4797 and the Sale of Main Home Worksheet?

Possibly.

When a property has been used as both a residence and a rental property, you may need to report the sale in two different areas of the return:

  • The personal residence portion on the Sale of Main Home Worksheet
  • The rental or business portion on Form 4797
This is typically required when part of the property was used as a separate rental or business unit and does not qualify to be treated as part of the residence at the time of sale.

How Do I Report the Rental Portion of the Property?

To report the rental or business-use portion, go to:
  1. Federal
  2. Income (Select My Forms)
  3. Less Common Income
  4. Sale of Business Property (Form 4797)
Depending on how the property was originally set up, you may need multiple entries.

Land

Land is not depreciable and is generally reported separately.

If held for more than one year, it is usually reported as:

  • Part I – Property Held More Than One Year

Building (Depreciable Portion)

The dwelling or improvement portion that was depreciated is generally reported as:
  • Part III – Section 1250 Property
The program will calculate the gain and any depreciation recapture based on the information entered.

How Do I Report the Main Home Portion?

To report the portion that qualifies as your principal residence:
  1. Federal
  2. Income (Select My Forms)
  3. Investments
  4. Sale of Main Home Worksheet
The worksheet determines:
  • Your gain on the sale
  • Whether you qualify for the exclusion
  • Any taxable gain remaining after the exclusion is applied

How Do I Allocate the Sale Between Personal and Rental Use?

If part of the property was used as a separate rental or business unit, you must allocate:
  • Sales price
  • Cost basis
  • Selling expenses
  • Depreciation
between the residential and rental portions.

The IRS allows any reasonable allocation method, such as:

  • Square footage
  • Number of rooms
  • Percentage of property devoted to rental use
  • Other reasonable usage calculations

Example

Suppose:
  • Total home size: 2,000 square feet
  • Rental unit: 500 square feet
Rental percentage:
500 ÷ 2,000 = 25%
You would generally allocate:
  • 25% of sales proceeds to the rental portion
  • 25% of basis to the rental portion
  • 25% of selling expenses to the rental portion
The remaining 75% would be allocated to the personal residence portion.

What Is Depreciation Recapture?

One of the most important parts of selling a former rental property is depreciation recapture.

If you claimed depreciation deductions while the property was used as a rental, the IRS requires you to recapture those deductions when the property is sold.

Even if you failed to claim depreciation, the IRS generally requires recapture of the amount that could have been claimed.

Can Depreciation Be Excluded Under the Home Sale Exclusion?

No. The home sale exclusion does not apply to depreciation claimed (or allowable) after May 6, 1997.

That portion of the gain is generally taxed as unrecaptured Section 1250 gain, which may be subject to a maximum federal tax rate of 25%.

How Do I Enter Depreciation Recapture?

To report depreciation recapture, go to:
  1. Federal
  2. Income (Select My Forms)
  3. Less Common Income
  4. Sale of Business Property (Form 4797)
  5. Allowable Depreciation

Enter the depreciation that was claimed or allowable during the rental period.

If the property was held longer than one year, the property type will generally be identified as:

  • Part III – Section 1250 Property

Special Rule for Military and Certain Government Employees

Military members and certain government employees on qualified extended duty may be able to suspend the normal 5-year ownership and use period for up to 10 years.

This special rule may help preserve eligibility for the home sale exclusion when an assignment requires living away from the home.

However, this rule does not eliminate:

  • Form 4797 reporting requirements
  • Depreciation recapture requirements

Additional Information

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