Question:   I lived in a home as my principal residence for the first 2 of the last 5 years. For the last 3 years, the home was a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the depreciation I took while it was rented out?

Answer:   You may be able to exclude the gain from the sale of a home that you used as a rental but you must meet the ownership and use tests and must not have excluded gain from the sale of a principal residence from gross income during the two year period that ends on the date of sale or exchange of your current principal residence. You cannot exclude an amount of the gain equal to the depreciation deductions claimed, or that could have been claimed, on your tax returns. However, if you have adequate records or other evidence that the depreciation deductions claimed on your returns were less than the amounts allowable, the amount of the gain realized on the sale that will not qualify for exclusion from income will be equal to the amount of the depreciation deductions claimed on your tax returns. Refer to Publication 523, Selling Your Home, and Form 4797 (PDF), Sale of Business Property, for specifics on calculating and reporting the amount of gain.