Capital Gains and Losses
Questions and comments about tax rules for buying and selling stocks, mutual funds, real estate and other assets.
how to determine basis for home converted to rental
Posted by: irc_nausea, July 12, 2017 05:01PM
I converted my residence to rental at the end of 2014. My depreciation deduction is based on market value of the home minus land at the time of conversion.

When I sell the home, is the gain/loss based on my original (adjusted) basis, or the market value at the time of the conversion?

This question is addressed briefly at the bottom of pg 4 in Pub 544, but the explanation leaves much to be desired.

Here's an example (using different numbers) that illustrates my situation:

2007 purchase price: $100k
capital improvements: $ 12k (prior to conversion)
2014 market value: $ 85k (at time of conversion)
4 years depreciation: <$ 10k>
2018 sale price: $ 95k

If I only look at what happened during the four year rental, there's a $20k gain. But I had an unrealized loss of $27k at the time of conversion, so overall there would be a $7k net loss if my basis at sale is $102k (100+12-10), which of course, would not be deductible.

I would be horrified if I lose the benefit of the $27k unrealized loss by having converted my home to rental!

Re: how to determine basis for home converted to rental
Posted by: irc_nausea, July 13, 2017 04:12AM
I found additional information in Pub 551 Basis of Assets (2016) which answers my question. The section Property Changed to Business or Rental Use makes it clear that losses (which only apply to business assets) are based on fair market value on date of conversion (or adjusted basis, if less) reduced by depreciation and other relevant basis adjustments during the rental period. On the other hand, gains are always based on the adjusted basis from original purchase date.

This explanation makes it clear there's a lot of room "in the middle" where there's neither a reportable gain or a loss, which is what I expect to happen in my situation.

Also note that the $200k exclusion for gains on sale of a personal residence only applies if the home is the owner's primary residence for 2 of the last 5 years prior to sale.

Re: how to determine basis for home converted to rental
Posted by: Drewremedy, July 19, 2017 12:00PM
WHy would you pick a lower market value as conversion value

Re: how to determine basis for home converted to rental
Posted by: irc_nausea, July 19, 2017 06:20PM
@Drew, I'm not sure if you're asking (a) why I picked the market value, which happened to be lower than adjusted basis at the time of conversion, or (b) why I picked a low market value.

(a) per pub 551: Basis for depreciation. The basis for depreciation is the lesser of the following amounts.
* The FMV of the property on the date of the change, or
* Your adjusted basis on the date of the change.

(b) A realtor ran a market comp analysis, something they can now do in just a few minutes with online data. I don't necessarily agree with the results, but its defensible and a lot less expensive (i.e., free) than getting an appraisal.

In any case, had the fair market value been higher at conversion, yes, it would have increased my depreciation deductions. But at the time (2014), I didn't imagine the market would still be down** in 2018. I thought I would end up with a taxable gain, in which case the depreciation would have been recaptured and thus the FMV at conversion would have been irrelevant.

** since the end of the Great Recession, our local market has entered a prolonged depression. I'm more fortunate than most, since my house is worth roughly 15% below its adjusted basis.

Re: how to determine basis for home converted to rental
Posted by: Donald001, July 22, 2017 07:04AM
Thank you.
the home price information is useful.



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