What IRS guidance applies to reporting a guest suite that was converted from short term rental AirBnB back to personal use due to HOA restrictions, with prior depreciation claimed?
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When a guest suite in your home that was previously used as a short-term rental (such as through AirBnB) is converted back to personal use due to HOA restrictions, several IRS rules and guidance apply to the reporting and tax treatment of the property, especially if you previously claimed depreciation deductions. The key issues are:
1. Change in Use: Rental to Personal
- When you convert a property (or part of a property) from rental (income-producing) use back to personal use, you must stop depreciating the property as of the date of conversion. Depreciation is only allowed while the property is held for the production of income or used in a trade or business.
- The IRS requires you to keep records of the date of conversion, as this determines when depreciation ends and when the property is no longer subject to rental property rules.
2. Reporting Rental Income and Deductions
- For the period the suite was rented, you must report all rental income and can deduct ordinary and necessary expenses, including depreciation, on Schedule E (Form 1040).
- After conversion to personal use, you can no longer deduct expenses related to the personal use period, except for certain expenses that may be allocated if the property was used for both personal and rental purposes during the year.
3. Depreciation Recapture and Basis Adjustments
- The total depreciation you claimed (or could have claimed) during the rental period reduces your adjusted basis in the property.
- If you later sell the home, the amount of depreciation claimed after May 6, 1997, must be "recaptured" as unrecaptured Section 1250 gain, which is taxed at a maximum 25% rate. This applies even if the property is used as your main home at the time of sale.
- The IRS provides a worksheet (Publication 523, Worksheet 3) to help determine the amount of gain that must be reported as unrecaptured Section 1250 gain due to prior depreciation.
4. Allocation of Expenses in Year of Conversion
- In the year you convert the suite from rental to personal use, you must allocate expenses (including depreciation) between the rental and personal use periods. Only expenses attributable to the rental period are deductible.
- For example, if the suite was rented for 3 months and used personally for 9 months, only 3/12 of annual expenses (including depreciation) are deductible as rental expenses.
5. Basis for Depreciation and Sale
- The adjusted basis of the suite for future depreciation (if reconverted to rental) or for gain/loss on sale is reduced by all depreciation allowed or allowable during the rental period.
- If you sell the home, you must allocate the gain between the portion used as a residence and the portion used for rental/business, if the suite was a separate unit. If the suite was within the living area and not a separate dwelling, you do not need to allocate the gain, but you must still recapture depreciation.
6. Relevant IRS Publications and Forms
- Publication 527: Explains the rules for residential rental property, including conversion to and from rental use, and how to allocate expenses and depreciation.
- Publication 523: Details the sale of a home, including how to handle prior depreciation and recapture when a home (or part of it) was previously used for rental.
- Publication 946: Provides comprehensive guidance on depreciation, including what happens when property is converted from business to personal use.
- Form 4562: Used to report depreciation and amortization, including for property converted from rental to personal use.
- Form 4797: Used to report recapture of depreciation as ordinary income if the property is sold.
- Revenue Ruling 72-588: This ruling confirms that when a home is rented during a period of absence, expenses and depreciation attributable to the rental period are deductible under Sections 167 and 212, but not considered as amounts expended to provide a home for purposes of the minister’s housing allowance exclusion. When the property is no longer held for rental, such expenses are not deductible.
7. Summary of Steps for Reporting:
- For the year of conversion, report rental income and allowable expenses (including depreciation) on Schedule E for the rental period only
- After conversion, do not claim further depreciation or rental expenses
- Keep records of all depreciation claimed, as this will affect your basis and potential recapture if you sell the property.
- If you sell the home, use Publication 523 and Form 4797 to determine and report any unrecaptured Section 1250 gain due to prior depreciation.
8. Key IRS Guidance:
- IRS Publication 527 (Residential Rental Property)
- IRS Publication 523 (Selling Your Home)- IRS Publication 946 (How to Depreciate Property)
- Form 4562 and Form 4797- Rev. Rul. 72-588
These sources provide the authoritative framework for reporting a guest suite converted from short-term rental back to personal use, with prior depreciation claimed.
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