Depreciation when Converting a Primary Home to a Rental
Depreciable basis is the value that can be claimed as depreciation expense over an asset’s useful life. (Noting that land is non-depreciable and will need to be backed out from the total basis) Code section § 1.168(b)–1T(a)(4) covers the specific guidelines when someone converts a personal use asset to business use-
The key principle outlined in this tax provision is that when a homeowner converts their primary residence into a rental property, the depreciable basis is determined by the lower of two values: the property's adjusted basis or its fair market value at the time of conversion.
Adjusted Basis: The adjusted basis typically refers to the original purchase price of the property, adjusted for various factors such as improvements, depreciation deductions, and certain closing costs. This figure provides a basis for calculating depreciation.
Fair Market Value at Date of Conversion: FMV represents the price that the property would sell for on the open market. When converting a primary home into a rental, if the FMV at the time of conversion is lower than the adjusted basis, the FMV is used as the depreciable basis.
Example: Let's say John purchased his primary residence for $250,000. Over the years, he made $50,000 worth of improvements. Ten years later he decides to convert it into a rental property, its adjusted basis at that point is $400,000.
The amount John gets to utilize as his Basis for determining rental depreciation is $300,000. He is required to use the lower of the two figures.
Why?
This prevents someone from being able to convert non-deductible personal losses to deductible rental losses. If you sell a personal property for a loss, that loss is not deductible. However, if you sell a rental property for a loss, it is deductible.