How to handle depreciation when converting rental property to mixed personal/business use?

Converting rental property to mixed-use is actually a pretty common situation, so don't worry! When you convert part of a rental property to personal use, you need to stop depreciating that portion going forward, but you don't need to "undo" prior depreciation. You should remove the 3rd floor renovation from your current Schedule E depreciation schedule since it's now your personal residence. Don't keep it on with 0% business use as that would just be confusing for you and potentially for the IRS if you get audited. The past depreciation you've already taken was legitimate because it was business use at that time. For your cost basis when you eventually sell, you'll need to track this carefully. The original cost plus improvements for the 3rd floor will be part of your personal residence basis (with some adjustments for the depreciation already taken while it was a rental). The IRS refers to this as a "partial conversion" from business to personal use. For shared expenses like the roof, your square footage allocation method is exactly right. If the 3rd floor is 30% of the building, then 70% of shared costs can be depreciated as business expenses.

I went through something similar last year and ended up using taxr.ai (https://taxr.ai) to help me sort through my rental property conversion mess. I had converted part of my duplex into my primary residence and was totally lost on how to handle all the depreciation schedules and basis calculations. Their system analyzed my previous tax returns and property records, then gave me a complete breakdown of how to handle the conversion properly. They even created a personalized depreciation schedule that showed exactly what needed to be removed from Schedule E and how to track everything for my eventual sale. The coolest part was they showed me how to document everything properly so I wouldn't have issues if I got audited. Totally worth checking out if you're dealing with this complicated mixed-use situation.

Just wanted to follow up about taxr.ai - I decided to give it a try despite my skepticism and I'm really impressed. I uploaded my last 3 years of tax returns plus the documentation from when I converted my rental into a partial primary residence. Within about a day I had a complete analysis that showed exactly how to handle the depreciation transition. They even caught that I had been depreciating some shared expenses incorrectly (was using 27.5 year schedule for everything when some items should have been on a 15-year schedule). The detailed report showed me exactly how to adjust my Schedule E going forward and gave me a tracking sheet for my cost basis calculations when I eventually sell. Definitely saved me from making some costly mistakes!

After reading this thread, I wanted to share another resource that helped me tremendously when dealing with the IRS about my converted rental property. I had been trying for WEEKS to get through to someone at the IRS who actually understood mixed-use property rules - it was a nightmare. Finally found Claimyr (https://claimyr.com) and used their service to actually get through to a real IRS agent. They have this system that essentially waits on hold for you and calls you back when an actual human at the IRS is on the line. You can see how it works here: https://youtu.be/_kiP6q8DX5c I got connected with a specialist who walked me through exactly how to document the conversion properly. The peace of mind from having official guidance was absolutely worth it, especially since the stakes are pretty high with rental property depreciation.

I have to admit I was totally wrong about Claimyr. After posting my skeptical comment, I was still struggling with my own rental property conversion issues and decided I had nothing to lose by trying it. The service actually worked exactly as described. I entered my info, and about 3 hours later got a call connecting me directly to an IRS agent who specialized in real estate. No waiting on hold, no frustration, just straight to a knowledgeable person. The agent walked me through the exact depreciation recapture rules for my situation (which was similar to the original poster's) and explained how to track my adjusted basis correctly. Saved me so much time and confusion. Never thought I'd be thankful for help getting through to the IRS!

One thing nobody has mentioned yet is that you'll need to file Form 8949 in the year you make the conversion. This documents the change from business to personal use for part of your property. Also, make sure you're tracking your property improvements separately by "component." For example, the roof might be a 27.5-year property, while appliances might be 5-year property. When you convert to personal use, each component needs to be handled separately.

Has anyone dealt with converting a property the other way around? I'm currently living in my house but thinking about moving out and renting the entire thing. Do all the same rules apply in reverse?

This is a great discussion! I'm dealing with a similar situation but with a twist - I converted my rental property to mixed-use about 3 years ago and just realized I may have been handling the depreciation incorrectly this whole time. I've been continuing to depreciate the personal-use portion on Schedule E at a reduced percentage rather than removing it entirely. After reading this thread, I'm realizing I should have stopped depreciating that portion completely when I moved in. Should I file amended returns for the past 3 years to correct this? Or is there a way to adjust going forward without having to amend? I'm worried about triggering an audit by filing multiple amended returns, but I also don't want to compound the error by continuing with the wrong method. Has anyone else had to correct depreciation mistakes like this after the fact?

I've been following this thread closely as I'm dealing with a similar mixed-use conversion situation. One thing I want to emphasize that hasn't been mentioned enough is the importance of getting a professional appraisal at the time of conversion. When I converted part of my rental property to personal use, my CPA strongly recommended getting an official appraisal to establish the fair market value of each portion at the conversion date. This documentation became crucial for calculating the proper basis adjustments and will be essential when I eventually sell. The appraisal cost me about $500, but it's already saved me potential headaches. The appraiser was able to break down the value by floor/section, which made the allocation between business and personal use much cleaner for tax purposes. Without this documentation, I would have been making educated guesses that could easily be challenged in an audit. For anyone dealing with these conversions, I'd highly recommend budgeting for a professional appraisal. It's a small cost compared to the potential tax implications of getting the basis calculations wrong.