Before You Turn Your Home Into a Rental Property

A house you live in and a house you rent out look the same from the street, but the tax code treats them as two different things. The change happens on a specific date, and that date sets the starting numbers for depreciation, for deductions, and for the tax bill you will face when you eventually sell. Many homeowners end up renting a former residence because the timing was wrong to sell, because the mortgage rate is worth keeping, or because they want the income. Many of them also wait until a preparer asks for paperwork a year later, when some of it is hard to recover. An afternoon spent on records now, and one conversation with a tax professional before the first lease is signed, costs far less than rebuilding the story afterward.

The day your home becomes a rental

The tax clock on a rental starts earlier than most people expect. The IRS treats rental property as placed in service once it is ready and available to rent, even if no tenant has moved in. Its own example describes an owner who moved out in July, made repairs through September, listed the house on October 1, and found a tenant on December 1, and the IRS treats that house as placed in service on October 1. That date is when depreciation and rental deductions begin. Write it down, and keep the listing, the first advertisement, or the email to a property manager as proof.

In the year of the change, bills that cover the whole year have to be divided between personal months and rental months. If you move out in May and start renting on June 1, seven twelfths of yearly costs such as property taxes and insurance belong to the rental, and monthly bills such as utilities become rental expenses starting in June. The personal months of mortgage interest and real estate taxes can still go on Schedule A if you itemize, but the personal months of insurance, and any depreciation for that period, cannot be deducted. A clear move out date and a clear ready to rent date, written on the same page, make the first rental return much easier to prepare. They also spare your preparer from guessing.

A house that sits empty while you search for a tenant can still support deductions, but only if you are offering it for rent. The IRS allows ordinary expenses for managing and maintaining a vacant rental, including depreciation, but lost rent during a vacancy is not deductible. If the house is listed for sale and is not also held out and available for rent, those expenses are not deductible rental expenses. The rent you charge matters too, because renting to a relative or friend below a fair rental price counts as personal use. The IRS says renting to a relative can be treated as personal use even when rent is paid, unless the relative uses the home as a main home and pays fair rental value. Personal use above the greater of 14 days or 10 percent of the days rented at a fair price moves the property into vacation home rules, and rental expenses then cannot exceed the rent received.

Records to gather before the first tenant

Your purchase file

Start with the closing statement from the day you bought the house. Settlement costs such as title insurance, recording fees, surveys, transfer taxes, and legal fees are part of your basis, while points, loan fees, and fire insurance premiums are not. If you built the house, gather the land contract and the builder and contractor invoices instead. You also need a split between land and building, because land cannot be depreciated. When the contract does not give a split, the IRS allows you to use the ratio of building to land shown on the property tax assessment, so keep your most recent assessment notice.

Your improvement receipts

Next, collect every receipt for work that improved the home while you lived in it. A new roof, a furnace, a remodeled kitchen, new flooring, a deck, and a water heater add to your basis, while painting, fixing leaks, and replacing broken hardware do not. Contracts, permits, invoices, and bank or card statements that show payment all count as support. Repair type work done as part of a larger remodel is generally treated as part of the improvement, so keep each project file together. Sort the pile by year and by room, and total it on a single sheet.

The value on conversion day

Third, document what the house was worth on the day it became a rental. Fair market value is the price a willing buyer and a willing seller would agree on, and sales of similar homes around the same date help establish it. A written appraisal, a price opinion from a licensed agent, or a comparable sales report dated close to the conversion date can all serve that purpose. Order it before the first tenant moves in, because an estimate made years later is harder to defend. This single number often decides how much depreciation you are allowed, as the next section explains.

Anything that lowered your basis

Fourth, list anything that reduced your basis during the years you owned the home. Casualty losses you deducted, insurance payments for damage, easement payments, certain energy credits, and depreciation you deducted for an earlier home office all reduce basis. Gain you postponed on an earlier home sale before May 7, 1997, and mortgage debt discharged on a qualified principal residence, can also require a reduction. If any of these apply to you, set aside the return or letter that shows the amount. Your preparer needs these figures to calculate your adjusted basis correctly.

The system for year one

Fifth, set up the records that will carry you through the first year. Form 1098 from your lender shows the mortgage interest you paid, so keep it with the property tax bills and the insurance declarations page. Open a separate checking account for rent deposits and rental expenses so every dollar in and out has a clear label. A security deposit you plan to return is not income, but a deposit that serves as the final month's rent is advance rent and counts as income when you receive it. Keep a mileage log for trips to the property, because the IRS requires records to support a vehicle deduction, and the standard mileage rate for 2025 was 70 cents a mile. Photograph each room on the conversion date and again at every tenant move in and move out.

How depreciation works on a house that used to be your home

Depreciation lets you recover the cost of the building over time, and it is the deduction most first time landlords have never calculated. You cannot depreciate a home while you live in it, but once you change it to income producing use, depreciation can begin on the date of the change. The basis for depreciation on a former home is the lesser of its fair market value or its adjusted basis on that date, and land is left out. The rule keeps a landlord from depreciating a drop in value that happened while the house was a personal asset. In practice, you compare two numbers for the building only, take the smaller one, and that becomes your starting point.

The IRS illustrates this with a house that had an adjusted basis of $164,000 and a market value of $168,000 on the conversion date, of which $21,000 was land and $147,000 was the house. Because $147,000 is smaller than $164,000, that smaller figure became the depreciable basis. Here is a simpler illustration with round numbers that are examples, not predictions. A homeowner paid $350,000 for a house, $70,000 of it land, and later spent $20,000 on a new roof, so the building's adjusted basis is $300,000. On conversion day the building is worth $336,000, which is higher, so the owner depreciates $300,000.

Residential rental buildings are depreciated on a straight line schedule over 27.5 years using a midmonth convention, which means you receive only part of a month's depreciation in the first month. The IRS percentage table gives 2.879 percent for the first year when the property is placed in service in March, and 3.636 percent for each full year after. On the $300,000 in our example, that is about $8,637 in the first year and about $10,908 in each full year after. The 3.636 percent figure is simply one divided by 27.5. Every month you wait to place the house in service shaves a little off the first year, which is one more reason to document the date.

Items you buy for the rental are depreciated separately from the house. Appliances, carpet, and furniture used in a residential rental are five year property, while a new roof or furnace added after the rental begins follows the same 27.5 year schedule as the building. The IRS says 100 percent special depreciation was restored for qualified property acquired and placed in service after January 19, 2025, so some items bought new for the rental may qualify for a larger first year deduction. Whether to take that deduction or spread the cost out is a decision for your preparer, because the choice changes the timing of your deductions across several years. Keep each purchase on its own line of a depreciation schedule with the date, cost, and category.

Skipping depreciation does not help you. If you do not claim some or all of the depreciation the law allows, you must still reduce the property's basis by the amount allowable before figuring gain on a sale. That means you lose the deduction in the years you rent and receive no benefit when you sell. Depreciation continues while the house is temporarily idle, such as during repairs between tenants, and stops when you sell the house or convert it back to personal use. Depreciation is reported on Form 4562 in the year you place property in service, and the amount carries to Schedule E.

Expenses you can deduct and how to sort repairs from improvements

The ordinary costs of operating a rental come off the rent you collect. Common deductible expenses include mortgage interest, property taxes, insurance, repairs, cleaning and maintenance, utilities, advertising, commissions, management fees, and legal and professional fees. Fees you pay to prepare the rental part of your tax return also count, and travel to manage or maintain the property is deductible when that is the primary purpose of the trip. Commuting between your home and the rental generally is not deductible. Principal payments on your mortgage are not an expense because they reduce what you owe rather than the cost of operating the property. A cash basis landlord also cannot deduct rent a tenant failed to pay, because that rent was never counted as income.

Refinancing and prepaid costs follow their own rules. When you refinance a rental for more than the old balance, the interest tied to money used for something unrelated to the rental generally is not deductible as a rental expense. Points on a rental loan are generally deducted over the life of the loan, not all in the year you pay them. An insurance premium that covers more than one year is deducted one year at a time. Each of these rules is simple on its own. Together they explain why a clean paper trail matters from the first month.

The question new landlords ask most often is whether a bill is a repair or an improvement. A repair keeps the property in working order and is deducted when you pay it, while an expense that betters the property, restores it, or adapts it to a new use must be capitalized and depreciated. Fixing a leak, repainting between tenants, and replacing a broken lock are typical repairs. A new roof, a new furnace, and a kitchen remodel are typical improvements. When one invoice mixes both kinds of work, ask the contractor to itemize it so each part can be sorted correctly.

Three safe harbors can simplify the sorting for small landlords. Under the de minimis safe harbor, you can deduct an item that costs $2,500 or less per item or invoice by making an election with your return each year. The safe harbor for small taxpayers covers buildings with an unadjusted basis of $1 million or less and allows you to deduct repairs, maintenance, and improvements for the year when the total stays under the lesser of $10,000 or two percent of that basis. A third, the routine maintenance safe harbor, can allow a deduction for recurring work even when the cost would otherwise be an improvement. The small taxpayer limit is all or nothing, so one dollar over it puts you back into the full repair versus improvement analysis. Ask your preparer which safe harbors to elect before the year ends.

Hiring help comes with paperwork. Ask each contractor for a completed Form W9 before the first payment so you have a name, address, and taxpayer number on file. Ask your preparer whether information return filing applies to your repair vendors, because the reporting threshold for certain Form 1099 payments rose from $600 to $2,000 for payments made after December 31, 2025. Keep every invoice and proof of payment in a folder for each property. Those habits turn a scramble at filing time into a quick review.

Reporting the rent and handling a loss

Rental income and expenses for a typical house rental go on Schedule E, Part I. You list income, expenses, and depreciation for each property and enter the number of fair rental days and personal use days. If you provide substantial services mainly for the tenant's convenience, such as regular cleaning or changing linens, the activity moves to Schedule C and may bring self employment tax. Basic services such as heat and light, trash collection, and cleaning of public areas do not trigger that rule. For a typical long term lease of a house, Schedule E is the usual home.

Depreciation often turns a profitable rental into a paper loss, so the loss rules matter in the first year. Rental real estate is generally a passive activity, passive losses generally cannot offset income other than passive income, and unused losses carry forward to the next year. A special allowance of up to $25,000 is available to landlords who actively participate, which means owning at least 10 percent and making management decisions such as approving tenants, setting rental terms, and approving repairs. The allowance is available in full when modified adjusted gross income is $100,000 or less, shrinks by 50 percent of the amount above that, and generally disappears at $150,000. A landlord above that range does not lose the deduction, because the unused loss carries forward.

Rent does not come with withholding, so ask whether quarterly estimated payments make sense. The 3.8 percent net investment income tax applies to the smaller of net investment income or the amount by which modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers, and no tax is withheld for it. Net investment income may include rental income. A landlord who qualifies as a real estate professional, with more than 750 hours in real property businesses and more than half of working time spent there, may be able to treat rental activities as nonpassive. Most people converting one home do not meet that standard, but it is a fair question for a preparer.

Be ready to show that you are renting to earn a profit. Rental income above expenses in at least three of five consecutive years creates a presumption of profit, and Form 5213 lets you postpone that determination during the early years. If the activity is not rented for profit, you still report the income but lose the rental deductions. Charging market rent, signing a written lease, and keeping organized records are the practical way to show your intent. A rental that loses money every year with little documentation invites questions you will want to be ready for.

How a future sale is taxed

How you eventually sell matters as much as how you start renting. The home sale exclusion of $250,000 for a single filer or $500,000 for a married couple filing jointly requires that you owned the home and lived in it as your main home for at least 24 months during the five years before the sale. The IRS confirms that a home rented for the three years before a sale can still meet this test. Nolo advises tracking that three year period carefully and selling before it runs out. You can take the exclusion only once in any two year period. Count the days from your move out date, and put the deadline on your calendar before the first lease begins.

The exclusion carries one firm limit for landlords. You cannot exclude the part of your gain equal to depreciation allowed or allowable for periods after May 6, 1997, and that portion may be taxed at a maximum 25 percent federal rate. The tax code counts the depreciation whether or not you claimed it. When a home has rental use in or before the year of sale, the IRS directs you to report the rental part of the sale on Form 4797. Any gain beyond the exclusion is reported on Form 8949 and Schedule D. Your preparer will use worksheets in IRS Publication 523 to sort each piece of the gain.

The timing of the rental period matters too. Rental time after the last day you used the home as your main home is not nonqualified use, so the common path of living in the house, moving out, and renting until you sell does not shrink the exclusion through proration. Renting first and living in the home afterward is different, and the IRS example of a property rented for two years and then lived in for two years allocates 40 percent of the remaining gain to nonqualified use. A rental stretch in the middle, followed by a move back in, follows the same logic. If you might return to the house, talk through that plan before you do it, because moving back does not erase earlier rental years.

Here is how the numbers work with the same round figures from earlier, which are illustrations and not a prediction. The owner paid $350,000, added a $20,000 roof, rented the house for about two and a half years, and deducted roughly $27,000 of depreciation. The home sells for $520,000 with $30,000 in selling costs, leaving $490,000 as the amount realized. The adjusted basis is $370,000 less $27,000, or $343,000, which produces a gain of $147,000. Assuming a single filer who meets the ownership and use tests, the $27,000 tied to depreciation is taxed at a maximum of 25 percent, which is up to $6,750 in federal tax, and the remaining $120,000 falls inside the $250,000 exclusion.

A sale at a loss is treated differently for a former home. A loss on the sale of a home you used only as your main home is not deductible. For a home converted to rental use and later sold at a loss, the starting point for the loss basis is the lower of original cost or fair market value on the date of conversion. That is a second reason the conversion day appraisal belongs in your permanent file. Taxable gain on a sale may also be subject to the 3.8 percent net investment income tax. Gain you exclude under the home sale rule is not counted as net investment income.

Some landlords consider an exchange instead of a sale. When a main home is converted to a rental and later exchanged for other property, the IRS explains that both the home sale exclusion and the like kind exchange rules can apply, with the exclusion applied first. The replacement property must be held for investment or business use and cannot be turned into a main home immediately after the exchange. Exchanges follow strict timing rules, so the planning has to begin before a sale contract is signed. Ask your preparer whether an exchange fits your goals or whether a straight sale with the exclusion is the better path.

Questions to bring to your tax professional

Questions about the conversion come first. Ask which date should be recorded as the placed in service date and how fair market value will be documented. Ask whether the land and building split on your assessment is reasonable for your property. Ask whether an earlier home office, a casualty loss, or a credit changes your adjusted basis. Ask how the first year's expenses will be divided between your personal months and your rental months.

Questions about expenses and losses come next. Ask which safe harbors to elect and what documentation each one requires. Ask whether you actively participate for purposes of the $25,000 allowance and what your modified adjusted gross income is likely to be, since that determines how much of a first year loss you can use. Ask whether quarterly estimated payments are needed once rent starts and how the net investment income tax could apply to you. Ask how state income tax, local rental licensing, and any local occupancy taxes apply, because those rules vary by location.

Questions about the exit should be asked before you rent, not after. Ask for the last date you could sell and still keep the exclusion, based on the days you lived in the house. Ask what your estimated depreciation tax would be after one, two, and three years of renting. Ask whether moving back in at any point would create nonqualified use. Ask whether holding the property in your own name or in an entity is right for you, and what an entity would do to your mortgage and insurance.

Before you hand over the keys

Tax planning is one part of this move, and several other calls protect the arrangement. Read your mortgage terms and tell your lender the house will be rented, since some loans carry occupancy requirements. Ask your insurance company about a landlord policy, because a standard homeowners policy may not cover a rented house in the same way. Check city and county rules for rental registration, inspections, and tenant notices, along with any HOA limits on leasing. Keep your home records until at least three years after the due date of the return that reports the sale.

This article is general information and not tax or legal advice. It reflects IRS publications for the 2025 tax year and guidance available as of October 2026, and your situation, your state, and future law changes may produce a different answer. Dollar figures in the worked examples are illustrations. Please review your specific facts with a CPA or enrolled agent before you convert your home.