I have found a bunch of links like the following that explain that the basis at sale when conversion FMV < initial purchase price is the purchase price.
https://www.kahnlitwin.com/blogs/tax-blog/converting-a-personal-residence-to-a-rental-property
https://www.marketwatch.com/story/want-to-convert-your-home-into-a-rental-property-here-are-the-tax-issues-2016-08-02
https://ecohencpas.com/consider-taxes-before-converting-your-home-to-a-rental-property/
Several other articles explain that IRS will only allow the FMV at conversion as the basis.
I havent found the IRS clause/para for the special basis treatment.
Which rule is correct?
Always go to the source; the IRS.
When you converted the property from personal use to rental, the basis for depreciation was lower of the Adjusted Basis or the FMV on the date of conversion.
Now that you are selling, it gets a little trickier.
Calculating Gain/Loss on Subsequent Sale of Rental Property
If a residence converted to rental property is later sold at a gain, the basis in the converted property is the original cost or other basis plus amounts paid for capital improvements, less any depreciation taken.
If the sale results in a loss, however, the starting point for basis is the lower of the property’s adjusted cost basis or FMV when it was converted from personal to rental property (Regs. Sec. 1.165-9(b)(2)). This rule is designed to ensure that any decline in value occurring while the property was held as a personal residence does not later become deductible on the sale of the rental property
Always go to the source; the IRS.
When you converted the property from personal use to rental, the basis for depreciation was lower of the Adjusted Basis or the FMV on the date of conversion.
Now that you are selling, it gets a little trickier.
Calculating Gain/Loss on Subsequent Sale of Rental Property
If a residence converted to rental property is later sold at a gain, the basis in the converted property is the original cost or other basis plus amounts paid for capital improvements, less any depreciation taken.
If the sale results in a loss, however, the starting point for basis is the lower of the property’s adjusted cost basis or FMV when it was converted from personal to rental property (Regs. Sec. 1.165-9(b)(2)). This rule is designed to ensure that any decline in value occurring while the property was held as a personal residence does not later become deductible on the sale of the rental property
Thanks Coleen, So say I bought at 320K and FMV was 230K at conversion. I have taken 41K of depreciation. Now if I sell at 280K net is it profit or loss ? ( basis is 320K-41K i.e 279K basis at time of sale)