Taxes
Primary Residence to Rental: The Depreciation Rules
Converting your home to a rental property? The depreciation basis is the lesser of cost or fair market value at conversion. The rules, a dual-basis worked example, and what to document.
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 quietly 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 actually changes when your home becomes a rental, with the dual-basis math 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, 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. Assume the tax assessment says the land is 25% of value.
| Input | Amount |
|---|---|
| Purchase price | $300,000 |
| + Improvements | $40,000 |
| Adjusted basis | $340,000 |
| FMV at conversion | $520,000 |
| Depreciation basis (lesser of the two) | $340,000 |
| − Land share (25%) | ($85,000) |
| Depreciable building basis | $255,000 |
| Annual depreciation (÷ 27.5) | $9,273/yr |
That $9,273 lands on Schedule E line 18 every full year the home stays in service (the first year is prorated by the mid-month convention from the placed-in-service month). 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.
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. For a home converted underwater (bought $400,000, worth $350,000 at conversion), the band between $350,000-less-depreciation and $400,000-less-depreciation is the no-mans-land.
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.
This date is also the line between personal and rental for every other expense: utilities, insurance, repairs. 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.
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:
- 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.
- 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. Our capital gains guide walks the post-window options (1031, harvesting the basis step-up, and when an outright sale still wins), and if the exit is an exchange rather than a sale, the 1031 rules for a converted primary residence set how long it must rent first.
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:
- FMV at conversion: an appraisal is best; comparable sales work. You need it even in an appreciated home, because it sets the loss basis.
- 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.
- Land/building split: the property tax assessment ratio is the standard source. Save the assessment page you used.
- Placed-in-service date: the listing date or lease availability date.
When we onboard a converted property in Oberlin24, these are literally the four fields the depreciation engine asks for: basis, land share, placed-in-service date, and the schedule builds itself from there onto line 18, with the accumulated total carried forward for the recapture math at sale. On our own books, the market-value versus cost-basis gap is real money (a two-property portfolio we track shows roughly $670k of market equity against $505k of book equity), and the lesser-of rule is why the books deliberately depreciate off the smaller number.
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 placed-in-service date starts the clock and the expense deductions, 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.
Frequently asked questions
What is the depreciation basis when converting a primary residence to a rental?
The lesser of two numbers on the conversion date: your adjusted basis (what you paid, plus improvements, minus any casualty losses claimed) or the property's fair market value. In an appreciated home the adjusted basis is lower, so that is usually your depreciation basis. You then subtract the land value, because land never depreciates.
How many years do you depreciate a converted rental property?
27.5 years, straight line, the same as any residential rental. The clock starts the month the property is placed in service as a rental (advertised and available, not necessarily occupied), with a mid-month convention for that first month. Prior years as your home do not count against the 27.5 years.
Can I still use the Section 121 home-sale exclusion after converting to a rental?
For a while. The exclusion requires that the home was your primary residence for 2 of the 5 years before sale, so you generally have up to 3 years after moving out to sell and still exclude up to $250,000 ($500,000 married filing jointly) of gain. The exclusion never covers the depreciation you claimed during the rental years; that part is recaptured regardless.
What happens if I sell a converted rental at a loss?
You compute the loss from the lesser-of basis (usually the conversion-date fair market value if the home had declined). Any decline in value that happened while it was your personal home is a nondeductible personal loss. There is also a no-mans-land: if the sale price lands between the gain basis and the loss basis, you report neither gain nor loss.
Do I depreciate the land when I convert my home to a rental?
No. Land never depreciates. Split your basis between building and land, most commonly using your property tax assessment ratio (assessed building value over total assessed value), and depreciate only the building share. Keep the assessment or appraisal you used for the split; it is the number an audit asks about.
What records should I keep on the date I convert my home to a rental?
Four things: evidence of fair market value on the conversion date (an appraisal, or comparable sales), your adjusted basis math (closing statement plus receipts for improvements), the land/building split source, and the placed-in-service date (the listing or first lease showing it was available for rent). These four numbers drive every Schedule E depreciation deduction and the gain or loss math at sale.