Question Regarding House Hack and Section 121

[Leo Q.]

Hello,

I've read that house hacking can cause tax implications at time of sale. One of those things being how much of the property qualifies for the section 121 of either 250k exemption or 500k if married. 

I own a primary residence that I've lived in for 3 years total but for the last 1 year I've been househacking my main floor and I've been occupying my basement. I haven't done taxes yet on my house hack but I was anticipating NOT claiming depreciation so I can avoid recapture tax when I sell the home.. but now im also worried that instead of the 500k that I thought I would be exempt for capital gains I may only have a portion of that available?

Does the IRS care about how long the property have been used as a "rental" to either full qualify or partially qualify for section 121? What would be my best course of action so that I can exempt the full 500k? This is a property that has appreciated significantly so I will need every penny of that 500k exemption. 

[Dave Foster]

@Leo Q., You're going to be fine on a couple of fronts.

1. The requirement is that you have lived in the property for 2 out of the 5 years prior to sale.  Which means you can buy a property and live in it for two years.  Move out and rent it for three more and sell before the end of year three and you would still qualify for the full exemption.

2. Unless the basement is a separate address/dwelling unit and the property is a SFR you can probably interpret that you are simply renting part of the shared living spaces. Which would allow you to not claim depreciation and still take the full 121 exemption.

3. And of course, if those two don't work you would always have the option of taking the 121 exemption on the portion you live in.  And doing a 1031 exchange on the rented portion thus avoiding both depreciation and getting part of the gain tax free while deferring the tax on the rest of the gain.