How do taxpayers report the change in use of a guest suite from short term rental to personal use on their 2024 Form 1040, given prior depreciation claimed under the Straight Line, Mid-Month method?
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To report the change in use of a guest suite from short-term rental (business/income-producing use) to personal use on the 2024 Form 1040, the taxpayer must follow specific rules for MACRS property that is converted from business to personal use. Here’s a step-by-step explanation, including the relevant legal details and reporting requirements:
1. Treatment of the Change in Use
- Depreciation in Year of Change: When MACRS property (such as a guest suite) is converted from business/income-producing use to personal use, the conversion is treated as a disposition for depreciation purposes in the year of change. The taxpayer is allowed a depreciation deduction for the portion of the year the property was used for rental purposes, calculated using the same method and convention as before the change (in this case, Straight Line, Mid-Month).
- No Immediate Gain or Loss: No gain, loss, or depreciation recapture is recognized at the time of conversion to personal use. However, any future sale of the property will require recapture of depreciation under section 1250.
2. Calculating Depreciation for 2024
- Partial-Year Depreciation: For the year of change (2024), the taxpayer calculates depreciation for the months the suite was used as a rental. Under the mid-month convention, the property is considered disposed of (for depreciation purposes) at the midpoint of the month in which the change to personal use occurs.
- Depreciation Calculation: Multiply the adjusted depreciable basis at the start of 2024 by the annual depreciation rate (from the MACRS table for the appropriate year of service), then multiply by the fraction of the year the property was in service (number of months, including fractions, divided by 12).
3. Reporting on the 2024 Form 1040
A. Schedule E (Form 1040)
- Rental Income and Expenses: Report all rental income and allowable expenses, including the partial-year depreciation, on Schedule E for the period the suite was rented.
- Depreciation Deduction: Enter the calculated depreciation for the rental period on the appropriate line of Schedule E. If the property was placed in service or disposed of (converted to personal use) during the year, Form 4562 must be attached.
B. Form 4562 (Depreciation and Amortization)
- Part III, Section B: Use this section to report depreciation for property converted to personal use during the year. Indicate the date of conversion and the amount of depreciation claimed for the rental period.
C. Basis Adjustment
- Stop Depreciation: After the conversion, no further depreciation is allowed. The basis of the property for future gain/loss calculations must be reduced by all depreciation allowed or allowable during the rental period.
4. Future Sale of the Property
- Depreciation Recapture: When the property (or the entire home) is eventually sold, the taxpayer must recapture as unrecaptured section 1250 gain the total depreciation claimed during the rental period, even if the property was later used for personal purposes.
- Reporting on Sale: At the time of sale, the taxpayer must use Form 4797 to report the recapture of depreciation, and Schedule D/Form 8949 for any capital gain.
5. Summary of Steps for 2024 Reporting
- Calculate partial-year depreciation for the guest suite using the straight-line, mid-month method, up to the date of conversion to personal use.
- Report all rental income and expenses, including depreciation, on Schedule E for the period the suite was rented.
- Complete and attach Form 4562 to report depreciation for the property converted to personal use.
- After conversion, do not claim further depreciation for the suite.
- Retain records of total depreciation claimed for future use when the property is sold, as this will affect gain calculations and recapture.
In summary: For 2024, report the rental activity and partial-year depreciation on Schedule E and Form 4562. After conversion to personal use, stop depreciating the suite. No gain or loss is recognized at conversion, but keep records of depreciation for future recapture when the property is sold.
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