Turning Your Home into a Rental: Tax Insights from Velin & Associates, Inc.

If selling your home quickly isn’t possible in today’s market, converting it into a rental property can be a smart way to generate income and take advantage of tax deductions. Rental income can often be sheltered through expenses like mortgage interest, property taxes, and depreciation.

However, the rules for converting a personal residence into a rental are nuanced. At Velin & Associates, Inc., we guide creators, online business owners, medical professionals, and high-net-worth individuals through these rules so they avoid surprises when it’s time to sell.

Depreciation: How the Special Basis Rule Works

When you convert a personal residence into a rental, you can depreciate the building portion over 27.5 years. But the special basis rule applies:

• Your depreciation basis = the lower of:
  1. The property’s fair market value (FMV) on the conversion date
  2. The property’s regular basis (purchase price + improvements − any prior deductions)

Example:

• Home purchase price: $400,000
• Renovations: $25,000
• FMV at conversion: $390,000

Depreciation basis = $390,000 (FMV is lower than regular basis $425,000). You can depreciate only $390,000 for tax purposes.

Deductible Losses When Selling

You cannot claim a loss on a personal residence. But after conversion, losses attributable to post-conversion declines may be deductible, applying the special basis rule.

Example:

• Regular basis: $400,000 + $25,000 improvements = $425,000
• FMV at conversion: $380,000
• Depreciation claimed after conversion: $15,000
• Special basis for loss: $380,000 − $15,000 = $365,000

If you sell the property later for $350,000:

• Deductible tax loss = $365,000 − $350,000 = $15,000

Calculating Taxable Gains

If your property appreciates after conversion, taxable gains are calculated differently:

• Gain basis = regular basis − post-conversion depreciation

Example:

• Regular basis: $425,000
• Post-conversion depreciation: $15,000
• Basis for gain: $425,000 − $15,000 = $410,000

If the property sells for $430,000:

• Taxable gain = $430,000 − $410,000 = $20,000

No Gain or Loss

Sometimes, the sale price falls between the special basis for loss and the regular basis for gain:

• Special basis for loss: $365,000
• Regular basis for gain: $410,000
• Sale price: $390,000

Result: no deductible loss and no taxable gain. Understanding this outcome helps with financial planning and avoids surprises at tax time.

Velin & Associates, Inc. Planning Tips

1. Convert Early if Market Is Soft: Post-conversion declines may create deductible losses.
2. Document All Improvements: Keep accurate records to calculate depreciation and basis correctly.
3. Separate Rental Accounting: Track rental income and expenses separately from personal use.
4. Work with a CPA Who Understands Your Business: Whether you’re a YouTuber, Shopify seller, Amazon business owner, dentist, or doctor, we can help you maximize deductions and plan for gains or losses.

Converting your home into a rental can be a smart financial move — but it requires careful planning. With the right guidance, you can take advantage of tax benefits and avoid unexpected consequences. For more information about our tax planning services, contact us today: visit our website.

Velin & Associates, Inc

8159 Santa Monica Blvd STE 198/200 West Hollywood, CA 90046
323-902-1000
dmitriy@losangelescpa.org

We help creators, doctors, dentists, high-net-worth individuals, and online business owners navigate complex tax rules and grow their wealth efficiently.

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