Rental to personal property

[FEDUKE404]

A client is planning to sell personal residence (will likely result in a tax-free event, partly due to depressed real estate market) and then move into a duplex, which will be converted to personal use. Apparently the plan is to knock out some walls, etc. to change from a duplex to a large home.

Both units of the duplex have been rented by client since 1995, and depreciation includes original costs plus some renovations/appliances/HVAC.

Assuming this conversion occurs during 2009, there should be NO current taxable event due to the depreciation issues.....correct?

The overall cost basis, for any future sale of the new residence, will be reduced by the allowed 1995 through 2009-ish depreciation. In simple terms, upon eventual sale how does one handle the depreciation that occured prior to/after the magic date of May 6, 1997?? (The majority of the depreciation is after that date.) I just see a real paperwork nightmare, especially since there are items (built-in appliances, bathrooms) that have been part of the overall depreciation schedule.

I'm trying to explain to the client that, if the residency rules are eventually met for the converted (duplex) unit, the client can in several years most likely sell the duplex and exclude most gain. There probably will be some taxable gain due to the $250k exclusion cap and/or depreciation recaptures.

At this stage, and having no idea what Congress will do in the next couple of years, is there a better explanation I could offer? I am getting pressure from client's investment advisor to find out how much "gain" will occur from both the sale of current residence and conversion of rental duplex to personal residence. It's almost as if I have a ticking time bomb and do not know how long the fuse is!

Sorry to be so lengthy, but just wanted to get the facts out.

Thanks!

FE

[joanmcq]

No gain from the conversion, but there will be depreciation recapture when he sells. You keep it on the books....my software has an option for disposition 'converted to personal do not recognize gain/loss' but if you do not choose to remove the asset, you can just keep it in the program in statsis forever. I'd give the client a depreciation schedule each year with no current dep on it,, just the accumulated, to give a heads up to anyone else that might end up preparing the return.

I wonder how often recapture that might happen years later actually gets reported. He is lucky he is converting this year. After this year, there will be a proration of allowable 121 exclusion based on primary residence/not primary residence periods of use.