Your cost basis begins with the actual amount you paid for the home. Improvements (whether paid by you or someone else) may influence the Fair Market Value (appreciation), but not your basis.
According to IRS Pub 551 Property Changed to Business or Rental Use:
If you hold property for personal use and then change it to business use or use it to produce rent, you must figure its basis for depreciation. An example of changing property held for personal use to business use would be renting out your former main home.
The basis for depreciation is the lesser of the following amounts.
- The FMV of the property on the date of the change, or
- Your adjusted basis on the date of the change.
The best source for the Fair Market Value (FMV) on the date of the change would be a local real estate agent who can provide comparable sales. This is good evidence for the value of your home on that date.
Your adjusted basis is the original purchase price plus any improvements (upgrades or additions) that you have made. Historical property tax records may provide the price you paid for the home. Improvement costs would come from your personal financial records.
In most cases, your adjusted basis would be less than the FMV, so that is the basis you would use for your Rental Property.
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