Primary Residence to Rental: The Depreciation Rules

Moving out of your house and renting it instead of selling it is one of the most common ways people become landlords. It is also the conversion the IRS wrote special basis rules for, and getting the starting numbers wrong on day one misprices every tax year after. The rule that surprises people: your depreciation basis is the lesser of your adjusted basis or the fair market value on the conversion date, and if the home ever sells at a loss, a second basis applies.

Here is what changes when your home becomes a rental, with the dual-basis math and a full first-year Schedule E worked out.

The lesser-of rule, in plain terms

From the day the home is placed in service as a rental, you depreciate it like any residential rental: straight line over 27.5 years, building only, never land. The question is what number you start from. IRS Publication 527 sets the depreciation basis at the lesser of:

• Adjusted basis: what you paid for the home (price plus the settlement costs that bought it, minus seller credits), plus capital improvements you have made since, minus any casualty losses you claimed; or
• Fair market value (FMV) on the date of conversion.

In a home that appreciated while you lived in it, the adjusted basis is the smaller number, so you depreciate off cost, not today's value. The rule exists to block the opposite case: if the home declined while you lived there, you cannot convert it and depreciate (or later deduct) the personal-years decline. Losses that happened while it was your house stay personal and nondeductible.

The worked example: one house, two bases

Say you bought the house for $300,000, added a $40,000 kitchen and roof over the years, and it is worth $520,000 the month you move out and list it for rent. The county assessment puts land at 25% of value.

Input	Amount
Purchase price	$300,000
+ Improvements while you lived there	$40,000
Adjusted basis	$340,000
FMV at conversion	$520,000
Depreciation basis (lesser of the two)	$340,000
− Land (25% of the $300,000 purchase)	($75,000)
Depreciable building basis	$265,000
Annual depreciation (÷ 27.5)	$9,636.36/yr

The land share comes off the purchase only. The kitchen and roof are all building, so none of the $40,000 is land. A common shortcut takes 25% of the whole $340,000, which makes land $85,000 and the building $255,000. That files $9,272.73 a year instead of $9,636.36, which is $363.64 a year and $10,000 of depreciation never claimed over the 27.5 years.

That $9,636.36 lands on Schedule E line 18 every full year the home stays in service (the first year is prorated by the mid-month convention, shown below). Note what did not matter: the $520,000 market value. In an appreciated home, conversion-date FMV affects the loss math later, not your deduction. The rental depreciation calculator runs the same schedule year by year.

Now the part the top-ranking guides gloss over. If you later sell, there are two different bases:

• Gain basis: the normal one, cost plus improvements minus depreciation. Sell above it and you have a gain.
• Loss basis: starts from the lesser-of number at conversion (FMV, if the home had declined by then) minus depreciation. Sell below it and you have a deductible loss.
• Between the two: no gain, no loss. A home that declined before conversion and sells in that band produces nothing deductible, by design.

For the appreciated house above the two bases are the same number, so this is invisible. Here is a home converted underwater instead: bought for $400,000, worth $350,000 the day it became a rental, same 25% land.

	Amount
Depreciation basis (FMV, the lower number)	$350,000
− Land (25% of $350,000)	($87,500)
Building basis	$262,500
Annual depreciation (÷ 27.5)	$9,545.45
Depreciation claimed by the sale (assumed)	$27,000
Gain basis ($400,000 − $27,000)	$373,000
Loss basis ($350,000 − $27,000)	$323,000

Sell for $390,000 (net of selling costs) and the gain is $390,000 − $373,000 = $17,000. Sell for $310,000 and the deductible loss is $323,000 − $310,000 = $13,000. Sell for $340,000 and you report neither. The $50,000 the home lost while you lived in it never becomes a rental deduction.

The clock: placed in service, not first tenant

Depreciation starts when the home is placed in service: ready and available for rent, which usually means listed or advertised, not the day a tenant signs. If you listed it in March and the lease started in June, your depreciation clock (and your ability to deduct expenses on Schedule E) starts in March. The mid-month convention gives you half of March plus April through December in year one, 9.5 of 12 months.

This date is also the line between personal and rental for every other expense: utilities, insurance, repairs, mortgage interest, property tax. Before it, personal. After it, rental deductions, subject to the normal rules. Keep the listing screenshot or the property manager agreement; it is the cheapest piece of audit evidence you will ever file.

Year one on Schedule E, line by line

Take the appreciated house above. You list it for rent on March 1, 2026. A tenant signs for June 1 at $2,800 a month. The lender's Form 1098 shows $12,000 of interest for the year, and the property tax bill is $6,000. With a March 1 start, 10 of 12 months of both are rental.

Schedule E line	2026	How it was figured
3 Rents received	$19,600.00	7 months × $2,800, June through December
5 Advertising	$150.00	Listing fee
9 Insurance	$1,000.00	Landlord policy from March, 10 × $100
12 Mortgage interest	$10,000.00	$12,000 × 10/12
14 Repairs	$380.00	Dishwasher pump, August
16 Taxes	$5,000.00	$6,000 × 10/12
17 Utilities	$450.00	March through May while vacant, 3 × $150
18 Depreciation	$7,628.79	$265,000 ÷ 27.5 × 9.5/12
20 Total expenses	$24,608.79
21 Income or (loss)	($5,008.79)

Three things fall out of that table. The January and February interest ($2,000) and property tax ($1,000) are personal, so they belong on Schedule A if you itemize, not on Schedule E. The vacant months still count: March through May has no rent but full rental expenses, because the home was available. And the $5,008.79 loss is a passive loss, so whether it offsets your wages this year depends on the passive activity loss rules (up to $25,000 for an active participant, phasing out between $100,000 and $150,000 of modified AGI).

The first year also needs Form 4562, with the home on Part III line 19h (residential rental property, 27.5 years, mid-month, straight line). From year two on, the full $9,636.36 goes on line 18.

Section 121: the three-year exit window

Converting does not immediately forfeit the home-sale exclusion. Section 121 excludes up to $250,000 of gain ($500,000 married filing jointly) if the home was your primary residence for 2 of the 5 years before the sale. Move out, rent it, and you generally have up to three years to sell with the exclusion intact.

Two catches that cost real money:

1. Depreciation is never excluded. The depreciation you claim during the rental years is recaptured at sale at up to 25%, even inside an otherwise fully excluded sale. The exclusion covers appreciation, not the deductions you took. In the example, three full years of depreciation is $28,909.08 that stays taxable even if every dollar of appreciation is excluded.
2. The exclusion shrinks with nonqualified use in some fact patterns (renting before it was your residence is treated differently than renting after). Rent-then-sell within the window is the clean direction.

So the conversion decision has a built-in deadline: if the plan is "rent it for a bit, then sell," selling inside the 2-of-5 window keeps the exclusion; drift past it and the whole gain, back to your original purchase price, is on the table like any rental. The sell, hold or 1031 calculator compares the post-window options side by side, including an exchange into another rental.

The four numbers to lock down on conversion day

Everything above runs off four inputs. Get them in writing the month you convert, because reconstructing them five years later is miserable:

1. FMV at conversion: an appraisal is best; comparable sales work. You need it even in an appreciated home, because it sets the loss basis.
2. Adjusted basis: closing statement plus every improvement receipt. Improvements made while you lived there count into basis; keeping those receipts is what makes the $40,000 kitchen deductible over 27.5 years instead of forgotten. Our free cost basis worksheet walks the closing statement to a starting basis and logs each improvement.
3. Land/building split: the property tax assessment ratio is the standard source. Save the assessment page you used.
4. Placed-in-service date: the listing date or lease availability date.

How Oberlin24 sets up a converted home

We built the depreciation setup in Oberlin24 around this exact case, since a home you lived in first is a common first rental. Here is what it does with those four numbers:

• It asks for the pieces, not the answer. Purchase price, the date it became a rental, settlement costs, seller credits, improvements made while you lived there, the value on the day it became a rental, and the county's assessed land and building figures. It works out the basis itself.
• It takes the lower number. If the conversion-day value is below your adjusted cost, the whole basis and the land split come from that value. If it is higher, cost stays.
• It keeps improvements on the building side. The land share applies to the purchase alone, the $75,000 in the example, not the $85,000 shortcut.
• It labels a guessed land split. With no assessment, it uses a state default (30% in California, 20% where it has nothing better) and marks it low confidence to replace with your county's figures.
• It catches double counting. If the same remodel is also logged as a separate improvement dated before the rental start, it warns you, so the work is not depreciated twice.
• It does not file a guessed line 18. For a newly converted home, building depreciation waits until a basis and a placed-in-service date are both set. Once they are, the schedule runs at 27.5 years with the mid-month first year, and the running total carries forward for the recapture math at sale.

You can see the line-18 schedule on a sample property in the demo.

The takeaway

Converting your home to a rental is a one-day event with a 27.5-year tail. The lesser-of rule sets your depreciation basis (usually your cost, not today's value), the land share comes off the purchase only, the placed-in-service date starts the clock and splits the year's interest and tax, and the 2-of-5 window gives you about three years to sell with the Section 121 exclusion. Lock down the four numbers on conversion day, and the rest is arithmetic your books should be doing for you. If the four numbers are already fuzzy, fix them this year, not the year you sell.