How to handle depreciation recovery on conversion from rental to residence?

Question

When a residential property has been rented for ten years and the property is converted back to the owner's private residence, what is the tax treatment of straight line depreciation taken over the ten years rental? No improvements were made during the rental period.

Is the transfer treated as a sale? (There is no change in ownership so no deed is involved.)

If it is a sale, how is the selling price established ? (The purchase cost, the depreciated price or the current market value, etc., etc?)

What federal form is all of this reported on?

Answer 1

No tax is due until you sell the home. When you sell the home, the depreciation allowable for the rental period will be recaptured from any gain on the sale of the home.

So keep those tax returns for the time you sell the home. The basis of the home is the basis when you started to rent it, minus the depreciation allowed during the rental period. It would be good to figure this out now and have it recorded in your own papers. Then when you sell it you can easily figure your taxes, or if someone inherits the house, they will know the amount of depreciation that will be recaptured.

Answer 2

This conversion is not a sale nor does it get reported on your tax return. When you sell your property, the sale gets reported on Form 4797. If you live in your home for at least 2 years after the conversion you could exclude $250,000 gain from tax ($500,000 if married). However, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997.