What basis applies when a home becomes a rental

For depreciation after a personal residence converts to rental use, the starting basis is generally the lower of adjusted basis or fair market value at conversion, excluding land.

The tax treatment

For depreciation after a personal residence converts to rental use, the starting basis is generally the lower of adjusted basis or fair market value at conversion, excluding land. This is a federal income tax starting point; the contract, ownership, accounting method, and actual use can change the result. State and local treatment should be checked separately.

The decision to make before filing

Establish conversion-date value and accumulated improvements before computing depreciation. The useful planning step is to resolve the classification while the underlying documents are still available, then reconcile it to the books and the prior-year return. If the transaction spans more than one year, track the opening balance and what happened to it afterward.

Illustrative example

A homeowner moves out and rents a house after its value has fallen below adjusted cost. For depreciation, the lower fair-market-value rule may apply at conversion. A dated appraisal and the home's purchase and improvement history allow the preparer to calculate the correct starting basis.

Records that support the position

Keep appraisal or comparable sales, historic purchase and improvement records, and first rental listing. Tie amounts on the return to bank activity and the agreement. When several assets, people, or uses are involved, write down the allocation method and apply it consistently. A short dated workpaper is easier to defend than a reconstructed explanation years later.

A common reporting error

Using today's market value after a decline can create depreciation the tax rules do not allow. Review both sides of the entry: a payment can affect income, basis, liability, or an expense at different times. A correct cash total alone does not establish the correct tax character.

Where to verify the rule

Start with IRS Publication 946: How To Depreciate Property. Its examples and cross-references explain the underlying federal rule; check the current version and any later IRS guidance for the year at issue. For a coordinated review of related deductions and limitations, see Real estate tax planning.

What basis applies when a home becomes a rental?