cash bought Primary residence to rental; capital gains and costs

[James Madison]

I've read through 10 pages of threads on conversions trying to answer my questions and haven't found the answer I'm looking for.

Here's the background.

• Primary residence (from 2011) purchase price: $10k
• County assessment (structure only): $70k
• Only about $2k in costs so far.

I've been in the house for over 2 years, so I'm sitting on my $125k capital gains exclusion (house would likely sell for $50k as is)... But I'm curious what a conversion to rental property would look like and be calculated.

Basically I'd like to remodel the whole house and add 1 bed and 1 bath. Which would probably be something like this.

• $40k remodel costs
• estimated county assessment (structure): $100k
• estimated sale price $110k

I have a feeling this is a stupid question, but I just can't find anyone in a similar situation.

Q: I can't deduct improvements, even after the conversion date, like I would a regular rental?

Basically, I want my cake and to eat it too... I want to deduct all my rental improvement costs AND not pay any capital gains for the sale up to $125-250k (say after I rent for a year or three)... But something tells me the tax man is smarter than that.

What would you do?... Please show math! :D

thank you!

[David Beard]

Well, your basis for depreciation when you convert to a rental is the lower of: cost (i.e. purchase + capital improvements) or fair market value. In your case, it almost certainly will be the cost.

The personal residence capital gains exclusion is $500k married, $250k single, and you can use it if you occupy the property for 2 of the prior 5 years. So you can hold it as a rental for close to 3 years and still take the exclusion, as long as you sell it (and close on it) prior to the 3-year anniversary of the conversion.