Converting a rental or vacation home into a primary residence

* When taxpayers change their principal residence to a current vacation home or rental investment property, certain tax intricacies can arise. * First, the taxpayers' Sec. 121 gain exclusion may be limited when they subsequently sell the vacation home or rental property. For instance, if they owned the home for eight years but lived there for only two, their gain exclusion upon selling it might be reduced by 75%. More broadly, the taxpayers will need to recognize gain from the home's sale allocated to periods of nonqualified use, generally meaning the time span when they did not use it as their principal residence. * An additional set of intricacies can arise when a former rental investment property becomes a principal residence. When the taxpayers subsequently sell the property, they may need to recapture depreciation deductions they took on it. In addition, potential pitfalls exist related to the use of passive loss carryforwards from the rental of the property.