@icnewer wrote:
What's the right "cost basis" in this case when calculate the depreciation? Should be original purchase 400k (+ any improvement cost and then minus land value as I know from IRS code) as the cost basis only as it's way lower than the FMV?
and later selling it after living 2+yrs, do I need to pay that depreciation recapture tax and why? And will the cost basis choice (between FMV vs. original purchase value) impact this recapture tax please?
You should have used 400k as the Basis for depreciation [the LOWER of (a) the Cost and (b) the Fair Market Value on the date of conversion to a rental].
Yes, the $250,000/$500,000 exclusion for your Principal Residence does not cover depreciation. It does not cover the GREATER of (a) the depreciation that you actually took or (b) the depreciation that you could have taken.
You also have "Nonqualified Use" for the rental period. That means that in addition to depreciation, a portion of the sale does NOT qualify for the $250,000/$500,000 Principal Residence exclusion.
