Converting primary residence into rental (mortgage is paid off): Can I take depreciation on this converted property for taxes?

[niravjpatel]

I just paid off mortgage on my primary residence and I am thinking of buying a bigger home (as a primary residence) while renting the existing home.  Can I depreciate current home (since it's going to be considered as a rental property) on my taxes or is it just available when you have mortgage on it?  Also if I take HELOC from the current house to pay down 20% on new house, can I take mortgage interest deduction on taxes?

[Modern Accounting Tax]

Yes you can depreciate your rental property.  Publication 527 discusses rental income and expenses (including depreciation) and explains how to report them on your return.

What Rental Property Can Be Depreciated? You can depreciate your property if it meets all the following requirements.• You own the property.• You use the property in your business or income-producing activity (such as rental property).•The property has a determinable useful life. The property is expected to last more than one year.

[soultax09]

Depreciation starts when the property is ready and available for rent.

[DanielV01 · Accepted solution]

Once you begin renting the property (or when it is available to rent), you not only can depreciate the home, but you are supposed to depreciate the home.  Since you are converting the residence to a rental, the depreciation basis will be the lower of the adjusted basis you have in the home or the Fair Market Value of the home (FMV).  If you don't take depreciation on this amount, then, at the time you sell the rental home outright, you will still have to claim depreciation recapture on the depreciation claimed or allowable.  Since that standard means you will have to account for the depreciation at the time of the home sale regardless of whether or not you actually claimed it, you should claim it.

With regards to your second question, no, you may not claim the HELOC interest as a deduction.  With regards to your personal residence, you can only claim HELOC interest if it is secured by the property producing the Line of Credit and the HELOC is used on the home itself.  In that limited case, the HELOC then becomes "acquisition debt" that allows for the amount to be deducted.  Since what you are proposing is to use a HELOC from another property to make the down payment, this interest is not deductible.  It also is not "business interest" either, because the funds are not being used for a business purpose.

If the situation were reverse (in other words, using a HELOC from a primary residence to fund a rental property), the interest might be deductible if there is a bona fide "business purpose" for the use of the funds.  This would be the case, for example if the rental activity "rises to the level of a business" per Section 162.  But, in your case, the situation would be the opposite.  No deduction would be allowed in this situation for the interest payments on the HELOC.

[Carl]

You don't have a choice here. You are required by federal law to depreciate rental property. The fact it's paid off doesn't matter.

Also if I take HELOC from the current house to pay down 20% on new house, can I take mortgage interest deduction on taxes?

Not on the SCH E you can't.  It could be  a SCH A deduction, but you don't even get that since it's used as a cash down payment. In order for the HELOC interest to be deductible on SCH E, you have to use the money to "buy, pay for or improve the same property, or a like kind property".  Since the new home to be purchased will be your primary residence and not rental property, it's not "like kind" property. So the interest on that HELOC will not be deductible at all.

[jsonp]

I have similar question. If i own a primary home fully pay off, I do cash-our refinance to take 100k. I use this 100k to buy new second home. I then convert first home to rental. is the mortgage interest treat at expense on rental income/business ?

[Carl]

You are required by federal law to depreciate rental property. Weather you have a mortgage on it or not, is totally irrelevant.

I do cash-our refinance to take 100k. I use this 100k to buy new second home. I then convert first home to rental. is the mortgage interest treat at expense on rental income/business ?

No. If the cash out was not used to "build or improve" the rental property, not one single penny of the interest is a SCH E deduction. If you used it to purchase a 2nd home that is your primary residence, 2nd home, vacation property or any other type of personal use real estate property, then the interest is an itemized deduction reported/claimed on SCH A.

[AmeliesUncle]

@jsonp   Your question was answered two weeks ago:

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/convert-home-into-rental-and-int...

[EDDIE911]

I paid off my house in 2007 and started renting it in 2021.

I know what I originally paid for it but do not know the land value.  What can I do? I do not have the property tax bill

[KrisD15]

Yes, you will depreciate the house as a rental. 

The basis in the rental, the amount you will base the depreciation on, is the lesser of the Fair Market Value or your adjusted basis. (What you paid, improvements made etc. ) 

Since home prices have gone up, it is reasonable to assume your adjusted basis is less. 

Yes, now you need a value for the house and for the land. 

Depending how long ago you bought a house, a Real Estate Broker or Appraiser could give you an estimate of what the value was when you bought.  

If that is not possible, ask a Broker to estimate what percentage the land value is to a property comparable to yours. 

OR 

Use your tax bill to do the same, divide the land value by the total property value. 

Say a house worth 500,000 in your area has a value for the land at 75,000. that would be 15% 

Next take what you paid and multiply by that percentage, in this case .15. 

So in this example, if you paid 125,000 for the land and house, the land was probably 18,750. (125,000 x .15)

The main thing is to use a method that is reasonable, document it and keep it with your tax file. 

When you go to sell the rental property, the depreciation will be recaptured, meaning you will most probably be tax on the amount of depreciation you took on the rental. BUT you have no choice, you cannot choose to NOT depreciate and not pay the depreciation recapture. That will be charged whether you took the depreciation or not.