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Dear Tax Talk,
Regarding basis for depreciation on rental property: IRS rules indicate to take the purchase price of the property and depreciate over 27 1/2 years, adjusted for any personal use.
However, I purchased a home in 2006 at $250,000, lived in it until 2014 and now am converting it to rental property. The home value as of the date it will be converted to rental property is much less than the $250,000 value from 2006. Is the basis for depreciation really the 2006 purchase price? Thank you for your assistance.
There is a special rule for property that was used for personal purposes before converting it to a rental property. If that is the case, the basis for depreciation is the lesser of either its adjusted basis or its fair market value at the time the property was placed in service for rental purposes.
In your situation, since the property has decreased in value, you will use the fair market value when you start renting it out.
You should keep a good record of your calculations to establish the basis you will use for depreciation — especially since you are held to the “lesser of” method. According to the IRS, the fair market value of the property is what it would currently sell for in the open market between a willing seller and a willing buyer. You can look to current similar property sales in your area to determine this amount.
Once you know the fair market value of the property, you then compare that amount with your adjusted basis of the property on the date the property was placed in service. Generally, this is your cost or other basis in the property, including any additions or capital improvements made to the property once you acquired it, minus any deductions for casualty losses claimed on prior year returns.
Thanks for the great question and best wishes in your new role as landlord.
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