When you convert your former residence to income-producing use then your rental depreciation deduction is based on the lower of the building's fair market value or its adjusted basis. You will need to exclude the value and basis of the land that the home is on for this comparison. The fair market value can be found using an real estate appraisal as of the day of conversion. The adjusted basis is generally the initial purchase price plus any capital improvements minus property losses and credits that were reported on prior year income tax returns.
Upon the sale of this property, a gain results if the sale proceeds are greater than the adjusted basis before conversion minus depreciation. A loss results if the sale proceeds are less than adjusted basis after conversion and after depreciation.
Example 1:
Year 1 = $200,000 purchase price [adjusted basis before conversion]
Year 10 = $250,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $100,000 sale proceeds
Year 20 = $28,000 capital loss [100 - (200 - 72)]
Example 2:
Year 1 = $200,000 purchase price [adjusted basis before conversion]
Year 10 = $250,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $300,000 sale proceeds
Year 20 = $172,000 capital gain [300 - (200 - 72)]
Example 3:
Year 1 = $250,000 purchase price [adjusted basis before conversion]
Year 10 = $200,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $100,000 sale proceeds
Year 20 = $28,000 capital loss [100 - (200 - 72)]
Example 4:
Year 1 = $250,000 purchase price [adjusted basis before conversion]
Year 10 = $200,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $300,000 sale proceeds
Year 20 = $122,000 capital gain [300 - (250 - 72)]