The information in this reply is correct. You must have lived in the house for at least two of the last 5 years to get the FULL exclusion of $250K or $500K to reduce the capital gains tax. You can further reduce the capital gain by adding the costs of preparing the house for sale. This would include adding major appliances, repairs, new landscaping, painting, etc. One more thing - The tax forms do allow for some pro-rating of the exclusion if you cannot meet the full two years. The tax form calls for the dates of during which you actually occupied the house.
By the way, if you used Schedule E to pay tax on the rental income and took depreciation, your return becomes a lot more complicated - there are extra forms to be filed - Sale of a business asset, depreciation adds to your profit, etc.
I recommend that you have your return prepared by a professional. I am pretty sure that your return would be "out of scope" for the AARP's Tax-Aide folks.
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