 Claiming
a loss on a home-turned-rental property
|  Dear
Tax Talk,
I purchased my first house four years ago and I
would like to sell it now. However, the community in which I live
in has seen declining values of homes due to foreclosure and subsequent
renters moving into the community. If I decide to rent my home for
a year and move into an apartment or another house, would I be able
to claim the loss that I take on selling my house after renting it
for a time period? Thanks. -- Russ
 Dear
Russ,
When you convert a personal-use asset to business
use -- such as your home -- the cost for calculating depreciation
is the lesser of its original cost or its fair market value. Publication
551 gives the following example:
Several years ago you paid $160,000 to have your home
built on a lot that cost $25,000. You paid $20,000 for permanent
improvements to the house and claimed a $2,000 casualty loss deduction
for damage to the house before changing the property to rental use
last year. Because land is not depreciable, you include only the
cost of the house when figuring the basis for depreciation.
Your adjusted basis in the house when you changed
its use was $178,000 ($160,000 + $20,000 - $2,000). On the same
date, your property had a fair market value of $180,000, of which
$15,000 was for the land and $165,000 was for the house. The basis
for figuring depreciation on the house is its fair market value
on the date of change ($165,000) because it is less than your adjusted
basis ($178,000).
If you later sell or dispose of property changed to
business or rental use, the basis of the property you use will depend
on whether you are figuring gain or loss.
Gain. The basis for figuring
a gain is your adjusted basis when you sell the property. Continuing
the example from Publication 551:
Example: Assume the same facts as in the previous
example except that you sell the property at a gain after being
allowed depreciation deductions of $37,500. Your adjusted basis
for figuring gain is $165,500 ($178,000 + $25,000 (land) - $37,500).
Loss. Figure the basis for
a loss starting with the smaller of your adjusted basis or the fair
market value of the property at the time of the change to business
or rental use. Reduce this by depreciation claimed.
Assume the same facts as in the previous example,
except that you sell the property at a loss after being allowed
depreciation deductions of $37,500. In this case, you would start
with the fair market value on the date of the change to rental use
($180,000) because it is less than the adjusted basis of $203,000
($178,000 + $25,000) on that date. Reduce that amount ($180,000)
by the depreciation deductions to arrive at a basis for loss of
$142,500 ($180,000 - $37,500).
To continue the example, if you were to sell
the property for between $142,500 and $165,500, you would have no
gain or loss for tax purposes. If you were to sell it for more than
$165,500 and less than $203,000, you would have depreciation recapture
up to $37,500. If you sold it for more than $203,000, you may be
able to exclude the gain under the home-sale rules if you used the
house for two years within the last five years on the date of sale.
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