Converting Primary Residence to Rental Property

Converting primary residence to rental property is the moment a house you lived in becomes an asset you hold for rent. Three clocks start to matter. The basis you may depreciate is fixed by the lesser of your adjusted basis and fair market value on the conversion date. Depreciation begins when the house is ready and available for rent, not when you first bought it as a home. The primary-residence exclusion, if you later sell, still looks back at whether you owned and lived in the home long enough, and it does not shelter gain equal to depreciation taken after May 6, 1997. This page is about that conversion. It is not a guide to getting a mortgage on a home you intend to occupy.

Illustrations here are not a rate quote and not an offer of credit. An inquiry is not an approval.

Converting Primary Residence to Rental Property Starts With Basis

Publication 551 and Publication 527 use the same rule. If you held the property for personal use and then change it to rental use, the basis for depreciation is the lesser of the fair market value on the date of the change or your adjusted basis on that date. Land is not depreciable. Split land and building before you apply the comparison.

Adjusted basis is what you paid, plus improvements still part of the house, minus casualty-loss deductions and other basis reductions Publication 551 describes. It is not the mortgage balance. It is not today’s list price unless that list price happens to be the lower of the two numbers.

Take a house whose building has an adjusted basis of $300,000 on the day you convert it. If an appraisal supports a building value of $280,000 that day, depreciation starts from $280,000. The $20,000 gap is not a loss you claim at conversion. If the building’s fair market value is $340,000, you depreciate $300,000, the lower adjusted basis. You do not step the basis up to market just because you moved out. A step-up of that kind is an inheritance rule, covered in whether to keep an inherited rental, not a conversion rule.

Improvements you made while you lived there are already inside adjusted basis if they were capital improvements. Repairs you make to get the house rentable, after you decide to rent it, may be repairs or capital items under the usual rental rules. Publication 527 points to that distinction. Do not add a new roof to the land line.

When Depreciation Starts, and the 27.5-Year Clock

You cannot depreciate a home during the years it is only your residence. Publication 527 says you begin depreciating rental property when you place it in service for the production of income, which is when it is ready and available for a specific use in the rental. You do not need a signed lease yet. You do need the property actually available to rent.

The publication’s own example matches a move-out. The owner moved in July, made repairs in August and September, and listed the house for rent on October 1. A tenant took it on December 1. Placed-in-service date: October 1, the day it was available for rent. Depreciation for that year uses the mid-month convention from October, not from July and not from December.

Under the general depreciation system, Publication 527’s Table 2-1 lists residential rental buildings and structural components at 27.5 years. You must use straight line and the mid-month convention. The same table lists a different recovery period if you elect the alternative depreciation system. Electing that system is a separate choice, made in the first year, and the publication says that for residential rental property the election is not revoked. Most converted homes that stay on the general system use 27.5 years on the building portion only.

Depreciation reduces basis. When you later sell, depreciation recapture on a rental is the part of the gain tied to depreciation you took or could have taken. Skipping a year you were allowed to claim does not preserve basis. Publication 527 says yearly depreciation, for the “fully recovered” test, includes depreciation you were allowed to claim even if you did not claim it. Convert, place it in service, and take the deduction you are allowed. Then keep the worksheets.

Personal use after the conversion changes the year. If you move back in and the house is no longer held for rent, you stop depreciating it when you retire it from income-producing use. A short stay is not the same as taking it off the rental market. The facts decide. Do not keep a full-year rental schedule for a house you reoccupied as your home in March without splitting the year.

The Primary-Residence Exclusion Clock

Publication 523 explains the exclusion of gain on the sale of a main home. The maximum exclusion is $250,000, or $500,000 if you are married filing jointly, and only if you meet the eligibility test. The ownership test is at least 24 months out of the last 5 years before the sale. The residence test is at least 24 months of residence during the previous 5 years. Those 24 months need not be a single block. The publication describes them as a total of 24 months, which it also states as 730 days. For a joint return, only one spouse must meet ownership. Each spouse must meet the residence test to claim the full $500,000. You can use the exclusion only once in a 2-year period.

Converting the house to a rental does not by itself erase that history. If you lived there for three years, moved out, and sold within a window where you still have 24 months of residence inside the 5 years ending on the sale date, you can still meet the test. Publication 523’s Taylor example is this pattern: personal use first, then a rental period, then a sale, with the ownership and use tests met. Gain up to the exclusion limit can be excluded. Gain equal to depreciation claimed or claimable for periods after May 6, 1997 cannot. In that example the depreciation was unrecaptured section 1250 gain and stayed taxable even though the rest of the eligible gain was excluded.

Nonqualified use is the other clock, and the direction of the rental matters. Publication 523 says gain allocable to periods of nonqualified use is not excludable. Nonqualified use means any period after 2008 when neither you nor your spouse used the property as a main home, with exceptions. One exception does most of the work on a typical conversion: any portion of the 5-year period ending on the sale that falls after the last date you used the property as your main home is not nonqualified use. Renting the house after you move out, then selling, often falls under that exception. The depreciation slice is still outside the exclusion.

The exception does not rescue a rental period that happened before the home was your main home, or a rental stretch in the middle followed by a move back in. Publication 523’s Finley example rented first, moved in later, and had to allocate part of the gain to that earlier rental period. If your timeline is “rented, then lived in, then sold,” read Worksheet 3 in Publication 523 before you assume the full $250,000 or $500,000 is available. A partial exclusion can exist when you fail the full test for specific reasons the publication lists. That reduction is its own worksheet. It is not a reason to guess a fraction.

A sale soon after conversion can still qualify if the 24-of-60-month tests are met. A sale many years later, after you have lived elsewhere for so long that you no longer have 24 months of residence in the 5 years before the sale, will not meet the residence test. The exclusion is a lookback from the sale date. Moving out starts a fade. It does not freeze the exclusion forever.

The House Is a Rental After That Date

From the placed-in-service date, underwrite it as a rental. Rent, vacancy, insurance, tax, repairs, and the loan payment are cash flow after debt service. The old homeowners policy is the wrong form once a tenant occupies the house. Switch it as part of the conversion, which is the point of landlord insurance versus homeowners insurance.

If the existing loan was made while you occupied the home, read the occupancy terms. A rental is a different use. Business-purpose financing for a non-owner-occupied rental is a separate product conversation from the loan you used when you lived there. Non-owner-occupied rental financing is that later question. It does not set your depreciation basis, and it does not extend the section 121 clock.

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Frequently Asked Questions

What basis do I depreciate after I move out and rent the house?

The lesser of fair market value or adjusted basis on the date you change the home to rental use, and only the building portion. Converting primary residence to rental property does not step the basis up to the sales price you hope to get. Publication 527 and Publication 551 both state the lesser-of rule. Land stays outside the depreciable number.

When does depreciation start if the house sits empty for a month?

When it is ready and available for rent. Publication 527’s example treats the listing date as placed in service even though the tenant moved in later. Repairs you finish before you offer the house can push that date back. The years you lived there are not depreciable.

How long is residential rental property depreciated?

Under the general depreciation system, Publication 527 lists residential rental buildings and structural components at 27.5 years, straight line, with a mid-month convention. An alternative depreciation system election uses the different recovery period in the same table and is a first-year choice. You depreciate the building basis, not the land.

Do I lose the home-sale exclusion the day I convert?

Not automatically. Publication 523 allows an exclusion of up to $250,000, or $500,000 if married filing jointly, when you owned the home and used it as your residence for at least 24 months of the 5 years before the sale. A rental period after the last date you lived there is generally not nonqualified use. Depreciation after May 6, 1997 is still not excludable.

Does this article explain a mortgage for a home I will live in?

No. The subject is a house leaving personal use and becoming a rental: basis, the in-service date, and the exclusion lookback. Financing you used while you occupied the home may not match a leased rental. Any later business-purpose loan is a separate decision from the tax clocks above.