Hi all, this post may belong over in the real estate forum, but it is definitely a tax question, so I thought I would post it here. I am an accidental landlord who is just figuring out some of the intricacies of real estate taxes and need to get some clarifications/advice to make an upcoming decision. I have read through IRS publication 527 and still have some questions.
I built a house out of pocket in 2004 as an owner/builder and did not keep very good records of what I spent building the house. I did 90% of the work myself, so my best guess of true cost basis is around half of the tax assessment value ($220K). I lived in the house until December 2013, when I moved and rented the house out. This means I have until December 2016 to qualify for the 2/5 rule if I decide to sell. I am leaning toward selling the house by December for several reasons, one of which is that I could claim the income as personal home capital gains - making up to $250K in gains tax exempt. The only problem with this plan is that allowable depreciation must be recaptured at the time of sale. I have not depreciated the property because I thought (incorrectly) that not claiming depreciation would avoid the recapture.
If I were to keep the house as a rental, I would need to determine a cost basis for depreciation. Publication 527 chapter 4 has a section called "basis of property changed to rental use". This says:
"When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion."
I know the adjusted basis would be lower than the FMV, but any number I come up with would still be a wild guess, without any receipts/documentation to back it up. It seems that no matter which direction I go I need to determine a cost basis. If I sell, a lower cost basis would be the best, because the allowable depreciation would be lower. If I continue to rent, a higher cost basis will allow me to claim more depreciation and save on taxes. Either way, my ignorance has already cost me money, so advice/face punches on the topic are welcome and appreciated. Any accountants out there who can offer any advice?