I have a rental property rented out for 2 years now. Can I move in the 3rd year and live for 2 years as primary resident, and sell, and do not incur the capital gain tax, because I would have owned for 5 years and lived for 2 years in it?

Is there any paperwork that needs to be done to declare that this is my primary residence in the third year?

#1;correct;as you said, capital gains tax can be a significant burden when selling an investment property. One way of reducing or eliminating your capital gains tax liability is by converting theental property into a primary residence in order to qualify for the primary residence exclusion of $250K for individuals or $500K for couples MFJ; To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have owned the home for at least 2 years (the ownership test), and lived in the home as your main home for at least 2 years (the use test). If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. However, the maximum amount you may be able to exclude will be reduced. for example, say you bought and moved into your main home in Sep. 2011. You sold the home at a gain in Oct. 2013. During the 5-year period ending on the date of sale in Oct. 2013, you owned and lived in the home for more than 2 years. you meet the ownership and use tests.However, as the pty was rental use home, you must recapture so called sec 1250 recapture on your return on form 4797 and the recapture ‘d be taxed as ordinary gain taxed at 25% aslongas your marginal tax rate is 25% or higher .



#2;I guess you need to contact your state's real estate department , to determine if there are any limits or restrictions regarding
The conversion