What are the rules for using Section 453 for the sale of a personal residence that has been rented out, and how does it interact with the Section 121 exclusion?

Question

Tyler Smith · Accepted Answer

Selling a property that served as both a personal residence and a rental can introduce complexity to a Section 453 installment sale. The Section 121 exclusion allows homeowners to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of a primary residence, provided they meet use and ownership tests. However, this exclusion does not apply to any portion of the gain allocated to depreciation claimed after May 6, 1997.

When such a 'mixed-use' property is sold on an installment basis, the gain must first be separated. The portion of the gain attributable to non-qualified use after May 6, 1997, and any depreciation recapture, are generally not excludable under Section 121. The gain that is eligible for the Section 121 exclusion is not taxable, and thus cannot be deferred under Section 453. Only the taxable portion of the gain that is not excluded under Section 121, after accounting for depreciation recapture, can be reported under the installment method. This requires careful calculation and allocation of basis and selling price between the personal use and rental use components of the property.