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If we move into the Texas home that was exchanged for the California rental home after several years, then it seems we would avoid both federal and ca tax except that part due to being a rental starting in 2009. Is that correct?

Roughly speaking, yes.

If you move into that house and live there for five years (rather than the usual two) you would qualify for the exclusion of up to $250k ($500k for a married couple) in gain on the sale.

But you would also have to deal with the non-qualified use issues for the rental period starting 1/1/09. That calculation is basically a proration of the gain. You'll take the number of months (or days) of non-qualified use (that would be the time from 1/1/09 until you move into the house) as the numerator. The denominator is the total time of ownership. Because the house was acquired in a 1031 exchange, you will add the ownership time from the previous houses to the ownership time of the current house.

Take that fraction and multiply times the gain. In this case, the gain will include the gains deferred from the MD and CA houses in the previous exchanges. That much of the gain is taxed in the year of sale. You'll also have to recapture the gain due to depreciation - which may be significant given your facts.

So there's no way the whole gain will escape tax. But a good chunk of it will.

I am not even going to ask if MD has a claim on any of the gain in the end!

I don't know MD law, but if I were to guess, I'd say that they probably do have a claim. I KNOW CA will want some tax because part of the gain is due to the property in CA.

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