Ask your CPA about a "1031" exchange, and see the link below.
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You don't indicate what the expected profit (gain), if any, would be. You would only have to be concerned with the capital gains tax if selling the rental house results in a profit. If so, you might consider a 1031 exchange, or consider moving into the house for 2 years as your primary residence.
The information presented here is general in nature and is not intended, nor should be construed, as legal advice. This posting does not create any attorney-client relationship with the author (who is only admitted to practice law in the State of California). For specific advice about your particular situation, consult your own attorney.
It is possible to defer the capital gain on the sale of a rental house by completing a Section 1031 exchange (deferred exchange). This is a technical procedure and you should seek the help of a professional to guide you through this process. If you make a mistake the gain you are attempting to defer will be taxable in whole or in part. If done properly the gain will be deferred into the new property you are acquiring.
Any individual seeking legal advice for their own situation should retain their own legal counsel as this response provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this response cannot be used to eliminate penalties with the IRS or any other governmental agency.
Because you own the house as a rental property, you can do a tax-deferred section 1031 exchange. However, you would have to acquire another real estate asset that you use for business/investment purposes. Also, please be advised that you cannot simply sell the house and buy another house. You generally have to engage the services of a section 1031 facilitator.
On the other hand, if you (and/or you and your spouse) live in the home for 2 years, you could potentially sell it and avoid taxes on up to $250,000 or $500,000 of gains ($250,000 if you live in the home alone; $500,000 if you and your spouse live in the home for 2 years). This exclusion is available under section 121 of the Internal Revenue Code and is only available once every two years.
This answer is provided as a public service and as a general response to a general question, it is not meant, and should not be relied upon as specific legal advice, nor does it create an attorney-client relationship. IRS CIRCULAR 230 NOTICE: To the extent that this message concerns tax matters, unless expressly stated otherwise, it is not intended to be used and cannot be used by the reader for the purpose of avoiding tax penalties that may be imposed by law. For more information about this notice, see http://www.irs.gov/pub/irs-utl/pcir230.pdf