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You are here: Home > I Just Got a Rental, What Do I Do? > Chap 2 - Initial Asset Management > Converting Primary Residence To A Rental

  • I Just Got a Rental, What Do I Do?

    • Introduction

      • About the Author
      • Progressive Updates
      • Introduction Disclaimer
      • Shameless Self-Promotion
      • Book Introduction
      • Quick Reference 2023
      • Quick Reference 2024
      • Glossary
    • Chap 1 - Ownership Arrangements

      • Real Estate and Rental Properties as a Business
      • Basic Business Entities For Real Estate Investment
      • Sole Proprietorship
      • Single-Member Limited Liability Company (SMLLC)
      • Multi-Member Limited Liability Company (MMLLC)
      • Limited Liability Partnerships (LLP) and General Partnerships (GP)
      • Rental Property In Partnership Entities
      • C Corporations
      • Rental Property In C Corporations
      • S Corporations
      • Pass-Through Versus Disregarded Entity Taxation
      • Your Spouse As A Business Partner (Happy Happy Joy Joy)
      • Owning A Rental Property With Others
      • Real Estate Investing With Family Partners
      • Real Estate Holding Company and Operating Company
      • Pure LLC Holding Company
      • Economic versus Equity Interests
      • Structuring Real Estate Deals with Angel Investors
      • Loans or Capital Injections
      • LLC Benefits For Rental Properties
      • Multi-Entity Rental Property Tiered Structure
      • Using a Trust In Your Real Estate Holding Company
      • Operating Agreements For Real Estate Partnerships
      • Real Estate Succession Planning
      • Fallacy Of A Nevada LLC (or Delaware, or Wyoming, or wherever!)
      • Liability Protection Fallacy Of An LLC
      • Charging Orders
      • Using A Self-Directed IRA Or 401k To Buy A Rental Property
      • Trapped Rental Assets In An S Corporation
    • Chap 2 - Initial Asset Management

      • Getting The Rental Business Launched
      • Rental Property Acquisition Costs
      • Real Estate Asset Setup On Your Tax Returns
      • Cost Segregation Study
      • Retroactive Look-Back Cost Segregation Study
      • Converting Primary Residence To A Rental
      • Moving Your Rental Property Into An LLC
    • Chap 3 - Rental Property Tax Considerations

      • Three Types of Income
      • Passive Activity Loss Limits
      • Passive Income Generators (PIG)
      • Your Small Business As A Passive Income Activity
      • Material Participation Rules
      • What Time Counts For Material Participation
      • Real Estate Professional Status (REPS)
      • Short-Term Rental (STR) Loophole
      • Vacation Home Rules
      • State Problems With Your Rental Property
    • Chap 4 - Rental Property Tax Deductions

      • Chapter Introduction
      • Five Basics to Warm Up To
      • Value of a Rental Property Tax Deduction
      • Rental Property Tax Deductions Themes
      • Section 199A Rental Property Deduction
      • Common Rental Property Tax Deductions
      • Allocation of General Rental Expenses
      • Rental Property Travel Deductions
      • Rental Property Meals
      • Mortgage Interest Tracing
      • Acquisition Costs (revisited)
      • Rental Property Repairs Safe Harbor (revisited)
      • Repairs Versus Improvements (revisited)
      • Rental Property Depreciation (revisited)
      • Automobile Deductions with Rentals
      • Automobile Decision Tree
      • Home Office Deduction
      • Real Estate Education Expenses
      • 185 Rental Property Tax Deductions You Cannot Take
      • Deductions the IRS Cannot Stand
      • Cohan Rule For Rental Property Owners
      • Reducing Taxes
    • Chap 5 - Operational Asset Management

      • Rental Property Repairs Safe Harbors
      • Improvement Versus Repairs
      • Rental Property Renovations (Rehab)
      • Accelerated Depreciation and Section 179 Deduction
      • Allowed Versus Allowable Depreciation
      • Qualified Improvement Property (QIP)
      • Partial Asset Disposition (PAD)
      • 1031 Like-Kind Exchange
      • Selling Your Rental Property
      • Buying Out Your Real Estate Partner
      • Taking The Rental Out of Service
      • Changing Depreciation Between 27.5 and 39.0 Years
    • Chap 6 - Retirement Planning

      • Retirement Planning Within Your Rental Property
      • Basic Retirement Planning
      • Tax Savings and Tax Deferrals
      • The Owners-Only 401k Plan
      • Roth 401k Plans
      • Roth 401k Versus Traditional 401k Considerations
      • Two 401k Plans
      • Rolling Old 401k Plans or IRAs into Your Small Business 401k Plan
    • Epilogue

      • Rental Property Tax Return Preparation
      • Rental Property Accounting
      • Real Estate CPAs
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  • Converting Primary Residence To A Rental
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Converting Primary Residence To A Rental

colorado springs cpaBy Jason Watson, CPA
Posted Monday, August 5 2024

This section isn’t as thrilling as others such as acquisition costs or 1031 like-kind exchanges, but at times it is an important consideration. Why would you want to convert your primary residence into a rental property (it is already a real estate investment of sorts, right?)? Here are some reasons-

You have an amazing mortgage interest rate, and don’t want to give it up necessarily. Keep in mind that mortgage interest can put a big dent into the internal rate of return (IRR) on a rental property. A 3% delta on a $400,000 loan is roughly a $1,000 monthly dent in cash flow. So, you need to go from $2,500 in rent to $3,500 just to break-even on the increased mortgage interest (sure, this assumes an early mortgage, and not one that you’ve had for seven years or more, but you get the idea).

You need to move quickly, but this year’s income is insanely high as compared to other years and your house’s gain exceeds the current $500,000 capital gains exclusion. This is a timing problem, right? Perhaps you can wait until next year to sell. You could also grab some cash with a home equity line of credit to tie things over. Cash-out refinance is more of a long-term commitment.

Your primary residence has been flat for a bit, and you suspect that there is a big boom coming to your geographic location. Therefore, you don’t want to sell before the prices start jumping but you also need to move for a job relocation. This allows you to cover your expenses with rental income while you await the wave of price increases on your way to an eventual sale with a nice rate of return.

Moreover, at times other investments in your risk profile are flat and you are concerned about where to park your money. Cash doesn’t seem like a good idea and buying another real estate investment puts you where you are today with a new data set of unknowns.

Perhaps your move is temporary. You are taking several years off to travel, visit the grandchildren, and drive your own children nuts. Why not? They drove you nuts, right? Parents forgive but never forget. However, your home is in a good location, has sentimental value and you plan to return later.

Rental properties can be tough to get into. Borrowing costs and underwriting guidelines can be more onerous when the property is not owner-occupied. Fortunately, the rental property investment landscape has favorably shifted towards traditional mortgage borrowing. However, and as many people in the military will tell you, moving from home to home, and converting prior properties into rentals can help accelerate your real estate acquisitions. Just a wake of homes converted into rentals- love it!

A few things to keep in mind as you look to convert your home into a rental-

  • According to Treasury Regulations 1.168(i)-4(b), your depreciable basis is either the adjusted basis on the date of conversion (what you paid for it) or the fair market value, whichever is lower. We’ll say it again, whichever is lower. Therefore, it does not matter that your property has increased in value.
  • There is some tax arbitrage potential here, however. Let’s say your property is going to decrease in value for whatever reason. Losses on primary residences are not tax deductible. However, if you convert your home into a rental property, and it continues to decline in value, then at the point of future sale you might have a tax-deductible loss.
  • If you plan to incur major renovation or remodeling costs, these expenditures should be made after the property has been placed into service (available for rent). This might allow for a higher depreciable basis of the rental property and increase your depreciation expense (partial asset disposition might come into play, which we discuss later). However, an argument could be made that your original purchase price plus the renovation becomes the combined adjusted basis. More discussion required,

The most important thing above all is to not visit your rental property. Some kidding aside, if this was your home where you raised children and manicured the lawn, it will be a gut punch on how others maintain your “business property.”

Jason Watson, CPA, is a Senior Partner of WCG CPAs & Advisors, a boutique yet progressive tax,
accounting and business consultation firm located in Colorado serving real estate investors worldwide.


Jason Watson CPA LinkedIn     Jason Watson CPA Email

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I Just Got A Rental, What Do I Do? 2024-2025 Edition

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