The same house is taxed three different ways depending on whether you live in it, rent it out or sell it. Here is one couple’s house worked through all three, with 2026 rules for returns filed in 2027.
The couple in this example is invented, but every rule and number comes from IRS publications and is computed from them. They file jointly.
| When | What happens | Tax effect |
|---|---|---|
| 2018 | Buy for $400,000 with a $320,000 mortgage; live there | Mortgage interest is an itemized deduction (Schedule A), if itemizing beats the standard deduction |
| 2020 | Add a $20,000 deck and new windows | Improvements raise basis to $420,000 |
| January 2022 to June 2024 | Live there (30 months) | Builds the 24 months of residence the exclusion needs |
| July 2024 | Move out; rent it from July | Becomes a rental: interest, taxes, insurance and depreciation go on Schedule E |
| December 2026 | Sell for $560,000 | Gain mostly excluded; depreciation recaptured |
Interest on up to $750,000 of mortgage debt taken out after December 15, 2017 is deductible, a limit P.L. 119-21 made permanent; their $320,000 loan is well under it. But the deduction only helps if they itemize. In a year with $11,500 of interest, $14,000 of state and property taxes and $3,000 of gifts, their itemized total is $28,500, less than the 2026 joint standard deduction of $32,200, so the interest saves them nothing that year. The mortgage interest deduction calculator runs that comparison and the debt limits.
Converting a home to a rental changes everything. Mortgage interest, property taxes, insurance and repairs become rental expenses on Schedule E, deductible against rent whether or not they itemize. And the building starts depreciating. Publication 527 sets the basis at the lesser of adjusted basis ($420,000) or market value at conversion ($480,000): $420,000, minus the $80,000 allocated to land, leaves a $340,000 building. Residential rentals use 27.5 years with the mid-month convention:
| Year | Depreciation |
|---|---|
| 2024 (July start: 5.5 months) | $5,666.67 |
| 2025 (full year, 3.636%) | $12,363.64 |
| 2026 (sold in December: 11.5 months) | $11,848.48 |
| Total depreciation | $29,878.79 |
The rental property depreciation calculator builds this schedule for any month and basis.
They lived in the house for 30 months between January 2022 and June 2024, all inside the 5 years before the December 2026 sale, so they pass the 2-of-5-year ownership and residence tests. The rental months came after they moved out and within that 5-year window, so Publication 523 does not treat them as nonqualified use. What the exclusion cannot cover is the depreciation.
| Sale | Amount |
|---|---|
| Sale price | $560,000 |
| Selling costs | −$33,600 |
| Amount realized | $526,400 |
| Adjusted basis: $420,000 − depreciation | $390,121.21 |
| Total gain | $136,278.79 |
| Depreciation recapture (not excludable) | $29,878.79 |
| Gain excluded (limit $500,000, married filing jointly) | $106,400.00 |
| Taxable gain | $29,878.79 |
| Tax on recapture at the 25% maximum | $7,470 or less |
Of a $136,279 gain, $106,400 is tax-free and the $29,879 equal to the depreciation is taxed as unrecaptured section 1250 gain, at no more than 25%. Had they waited until after June 2027 (3 years after moving out), they would no longer have 24 months of residence in the 5-year window and the whole gain would be taxable. The home sale tax calculator handles the exclusion, partial exclusions and recapture.
Had they rented the house out first and moved in later, the rental years would count as nonqualified use, and that share of the gain (after depreciation) would be taxable too. Publication 523’s own example: 2 of 5 years rented first made 40% of a $300,000 gain taxable even though the owner met the 2-year tests.
Itemizing out of habit when the standard deduction is larger. Using the purchase price instead of the lower market value when a home is converted to a rental in a down market. Skipping depreciation on a rental: the IRS counts depreciation you were entitled to, claimed or not. Waiting too long to sell a former home that has become a rental. Losing improvement receipts, which are the only proof of a higher basis. Using a parent’s purchase price for an inherited house: inherited property generally takes its value at the date of death as its basis, which the inherited property basis calculator works out, along with gifts and a surviving spouse’s half step-up.
State taxes, the 3.8% net investment income tax, passive loss limits on the rental years, selling-year proration of property taxes, and a 1031 exchange are all outside this example (a rental that is exchanged for other investment real estate instead of sold can defer the gain; the 1031 exchange calculator shows the boot, deferred gain and new basis). So is seller financing, which spreads the taxable gain over the years the buyer pays while depreciation recapture stays taxable in the year of sale; the installment sale calculator follows Pub 537 for that. A home damaged in a federally declared disaster raises a different question, covered by the casualty loss calculator and its $100 and 10%-of-AGI rules from Pub 547. It is an illustration, not tax advice; a tax professional is worth it for any sale of a home that was also a rental.
IRS Publication 936, Home Mortgage Interest Deduction (2025). IRS Publication 527, Residential Rental Property (2025). IRS Publication 523, Selling Your Home (2025, revised Feb 2026). IRS Publication 946, How to Depreciate Property (2025, revised March 2026). IRS Rev. Proc. 2025-32 (2026 standard deduction). IRS Topic 409 (reviewed Sept 24, 2026).
Yes, as a rental expense on Schedule E, not as an itemized deduction.
The lesser of your adjusted basis or the market value on the conversion date, minus the land.
Yes if you lived there 2 of the 5 years before the sale, which usually means selling within about 3 years of moving out. Depreciation is taxed either way.
The gain equal to depreciation on real estate is taxed at a maximum 25% rate.
Yes. Rental periods after 2008 before your last use as a main home are nonqualified use, and that share of the gain is taxable.
Only if your itemized deductions exceed the standard deduction, $32,200 for married couples filing jointly in 2026.