Rental property owners can convert an existing rental into a personal residence. The property may have been your home before you converted it into a rental. Converting a rental property to personal use is easy to do, you just take possession after the tenant vacates. For the tax year of conversion, calculate the allocation between deductible rental expenses and non-deductible personal expenses. You cannot take depreciation deductions after the conversion year. Prior depreciation deductions reflect in the calculation of taxable gain at property sale.
Calculate the total days of personal use and total days rented to others. If you personally used either 14 or more days or 10 percent or more of the total days you rented it to others, then you used it as a home. For example, six days personal use compared to 30 days rented to other yields a 20 percent factor -- 6/30 x 100 = 20 percent.
Withhold reporting any rental income or expenses, including depreciation, if you used it as a home but did not rent it 15 or more days to others. Report qualified property expenses, such as mortgage interest or property taxes, on Form 1040 Schedule A if you itemize your deductions.
Calculate the business use ratio for dividing rental expenses if you used it as a home and rented it 15 or more days to others. Divide days used as a rental -- the days actually rented, not just available for rent -- by the total days of use -- the days used as a rental plus personal use days. For example, rental use of 275 days compared to total use of 365 days yields a 75 percent factor -- 275/365 = 75 percent.
Multiply rental expenses by the business use ratio and deduct the business portion of these expenses on Form 1040 Schedule E. Do not deduct the personal portion of rental expenses. Deduct business expenses only to the extent of rental income. Carry forward any excess business expenses until you sell the property. Withhold calculating or reporting depreciation for tax years after the conversion.
Calculate home gain or loss when the property sells. Use Worksheets 1, 2 and 3 in IRS Publication 523 to perform calculation. Report any taxable gain on Form 1040 Schedule D.
Retain all prior tax returns that include rental property schedules. Use these to determine the amount of depreciation recapture upon property sale.
If you need additional assistance, contact a qualified tax professional for advice.
Things You'll Need
IRS Form 1040 with schedules
IRS Publication 523