REI fudged the tax basis calculations

[George P.]

ran into a REI investor yesterday and we got to talking about his rental properties (that he apparently sold).

he suggested that the last one he sold, was originally converted from a primary residence.

his calculation of the tax basis use the FMV of the property at the time of conversion. I don't quite remember the numbers, but the property price more than doubled by the time he converted it. By the time he sold it, it went up in price some more.

His reasoning is that he should not pay the capital gain on the amount the property appreciated before he converted it, because the proceeds would otherwise be tax-free (due to primary residence $500k exclusion). He only pays capital gain on the amount the property appreciated after he converted it (plus depreciation recapture).

I see his point and understand that in Canada they use FMV at the time of conversion.

--> Thoughts from the REI veterans on this strategy, potential issues with IRS etc. ?