Converting a Personal Residence to Rental Property
"There are many scenarios that could turn the family home into a rental property: new job, growing family, temporary re-location, etc."
What is the value of the property?
At the time when the property is converted to a rental, the owner needs to know both (1) the adjusted basis of the property (original cost, plus improvements, less any depreciation taken), and (2) the fair market value of the property. Obtaining an appraisal when the property is converted to rental will help establish the fair market value for current and future use. At a minimum, a REALTOR® market value assessment should be obtained to help substantiate fair market value.
The property’s basis is important for two reasons. First, it is used to determine the amount of depreciation expense that can be taken during the time the property is rented. For purposes of calculating the annual depreciation allowance, the lower of (1) the adjusted basis on the date of conversion, or (2) the fair market value at the time of conversion is used. Secondly, it is used to determine the gain or loss when the property is eventually sold (discussed later).
What expenses should be tracked?
A rental property is a business. Expenses necessary for managing, conserving or maintaining your rental property are deductible expenses. Some of the most common rental expenses are:
· Advertising
· Auto and travel expenses
· Cleaning and maintenance
· Rental commissions
· Depreciation
· Insurance
· Legal and other professional fees
· Management fees
· Mortgage interest
· Repairs
· Taxes
· Utilities
It is vital that records are kept to support all expenses claimed on the rental property.
What happens when the property is sold?
At the time of sale, a gain or loss on the sale is calculated. If there is a gain on the sale, the adjusted basis of the property is used for the calculation. If there is a loss, then the lower of adjusted basis or the fair market value of the property on the date of conversion is used in the calculation.
"As the owner of property that has been converted from a personal residence to a rental property, you may still be able to take advantage for the gain exclusion rules for a residence. Please check with your tax professional on these exclusions. It is important to note, however, that the amount of depreciation that was an allowable deduction during the rental period will not be excluded and will be taxed at sale."
It is important to note, however, that the amount of depreciation that was an allowable deduction during the rental period will not be excluded and will be taxed at sale.
Converting your personal residence to a rental property can be a reasonable solution in a variety of circumstances. However, there are many factors to consider when making the decision, many of which can have current and future tax implications. If you are considering converting your residence to a rental property, please consult your tax advisor to discuss your unique situation.
Submitted by: Mary Eshelman, CPA Swanson, Eshelman & Gamage LLC
IRS CIRCULAR 230 DISCLOSURE: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter
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