Tax implications of selling primary residence that has an "in-law" apartment.

Milford, CT · Member since 2017 · 15 posts · 2 votes

Hello,

My single-family home has a legal "in-law" apartment. I was hoping someone could help provide clarification on the tax implications of selling. Here are the details:

-Legal single-family home with an "in-law" apartment

-I rented the apartment on Airbnb and took 50% depreciation when I rented it

-I stopped renting the apartment over a year ago and then utilized the entire home as my primary residence (I did not claim the apartment on 2025 taxes, and I claimed the entire home as my primary residence in 2025)

-I lived in the home for a total of 5 years

I understand that I will have to pay taxes on the depreciation that was taken, but will the 121 exclusion apply to the entire property when I sell it? Thank you!

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Rohullah Sharifi

Dr · VA · Member since 2025 · 154 posts · 34 votes

1mo

I would say this depends how the tax return is filed and STR is reported to the IRS. If depreciate is taken and then last year stopped. Still the Recapture is there.

Secondly, you qualify for the gain exclusion as residency test is met. Please let me know if you need any advise/assistance.

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Rohullah Sharifi
Dr · VA · Member since 2025 · 154 posts · 34 votes
1mo
I would say this depends how the tax return is filed and STR is reported to the IRS. If depreciate is taken and then last year stopped. Still the Recapture is there.
Secondly, you qualify for the gain exclusion as residency test is met. Please let me know if you need any advise/assistance.
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- Paul D.
  OP
  Milford, CT · Member since 2017 · 15 posts · 2 votes
  1mo
  Quote from @Rohullah Sharifi:
  
  I would say this depends how the tax return is filed and STR is reported to the IRS. If depreciate is taken and then last year stopped. Still the Recapture is there.
  Secondly, you qualify for the gain exclusion as residency test is met. Please let me know if you need any advise/assistance.
  I claimed 50% rental for 3 years, then took the rental portion out of service and claimed the entire house as primary last year, and will claim the entire house as primary this year. Did NOT do anything fancy on taxes, such as accelerated depreciation/etc...
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- Rohullah Sharifi
  Dr · VA · Member since 2025 · 154 posts · 34 votes
  1mo
  Quote from @Paul D.:
  
  Quote from @Rohullah Sharifi:
  
  I would say this depends how the tax return is filed and STR is reported to the IRS. If depreciate is taken and then last year stopped. Still the Recapture is there.
  Secondly, you qualify for the gain exclusion as residency test is met. Please let me know if you need any advise/assistance.
  I claimed 50% rental for 3 years, then took the rental portion out of service and claimed the entire house as primary last year, and will claim the entire house as primary this year. Did NOT do anything fancy on taxes, such as accelerated depreciation/etc...
  
  Have you reside for two years after the removal of the STR? If yes, might work out. You need an experienced accountant to properly classify and prep the return.
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Marina Draper
Accountant · We serve all 50 states · Member since 2015 · 90 posts · 50 votes
1mo
Did you live in the property for at least 2 years prior to renting it out? Also, how do you use the in-law unit when it's not rented out?

This is a very tricky situation, I recommend having your taxes done by a professional.
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- Paul D.
  OP
  Milford, CT · Member since 2017 · 15 posts · 2 votes
  1mo
  Quote from @Marina Draper:
  
  Did you live in the property for at least 2 years prior to renting it out? Also, how do you use the in-law unit when it's not rented out?
  
  This is a very tricky situation, I recommend having your taxes done by a professional.
  
  I've always lived in the property and put the inlaw apartment into use shortly after I moved in. By the time I sell the property, the inlaw apartment will be out of use for 2 years. (purchased home: lived in 50%/rented 50% for 3 years, then took the rental portion out of use for 2 years and claimed the entire house as primary, lived in property for a total of 5 years).
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
1mo
@Paul D. , you are correct; you would still have to recapture any depreciation taken on the property when it was a rental unless you did a 1031 exchange. Since you used part of the property as your primary residence, you would still be able to take advantage of the 121 exclusion, but since you also used a portion of the property for investment, you can do a 1031 and avoid additional tax, if there is any, plus depreciation.

This would allow you to reinvest into another investment property and take tax-free cash from the primary exclusion.

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Jason MalabuteBusiness Member
Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 898 votes
1mo
You've got the core of it right. The depreciation you claimed while renting the in-law unit has to be recognized as gain when you sell — that piece can't be sheltered by the Section 121 exclusion and gets taxed as unrecaptured Section 1250 gain, and moving the whole house back to personal use doesn't erase it. The good news is that because you owned and lived in the home as your primary residence for at least two of the last five years, you do meet the use test for the Section 121 exclusion. The thing that really drives your result is whether that in-law apartment counts as part of the same dwelling unit or as a separate dwelling unit: if it's within the same dwelling unit, you generally don't have to allocate, and the exclusion can cover the gain on the whole property (still minus that depreciation piece) now that you've used the entire home as your residence for two full years; if it's treated as a separate unit, the gain may need to be allocated so that only the residence portion qualifies. That distinction is exactly why this one is worth having a preparer look at closely before you sell. The exact treatment depends on your specific facts, so I'd confirm it with your own CPA.
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- Paul D.
  OP
  Milford, CT · Member since 2017 · 15 posts · 2 votes
  1mo
  Quote from @Jason Malabute:
  
  You've got the core of it right. The depreciation you claimed while renting the in-law unit has to be recognized as gain when you sell — that piece can't be sheltered by the Section 121 exclusion and gets taxed as unrecaptured Section 1250 gain, and moving the whole house back to personal use doesn't erase it. The good news is that because you owned and lived in the home as your primary residence for at least two of the last five years, you do meet the use test for the Section 121 exclusion. The thing that really drives your result is whether that in-law apartment counts as part of the same dwelling unit or as a separate dwelling unit: if it's within the same dwelling unit, you generally don't have to allocate, and the exclusion can cover the gain on the whole property (still minus that depreciation piece) now that you've used the entire home as your residence for two full years; if it's treated as a separate unit, the gain may need to be allocated so that only the residence portion qualifies. That distinction is exactly why this one is worth having a preparer look at closely before you sell. The exact treatment depends on your specific facts, so I'd confirm it with your own CPA.
  
  Thank you!
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