Business Tax Preparation · Business assets

Converted property

Property moved between personal and business use does not simply change columns. The direction of the move determines which rules apply, and a conversion into business use can leave a single asset carrying three different figures: one for depreciation, one for gain and one for loss.

The rule

Depreciation after a conversion in. where property not previously used in a trade or business or held for the production of income is converted to such use, the fair market value on the date of conversion, if less than the adjusted basis at that time, is the basis for computing depreciation^TY2026Verified 2026-08-21Reg. § 1.167(g)-1, opened at law.cornell.edu/cfr/text/26/1.167(g)-1 (Reg. § 1.167(g)-1). The cap is on the depreciation basis specifically.

And the clock starts now. on a conversion to business or income-producing use, depreciation for the year of change and later years is determined as though the property were placed in service on the date of the conversion, using the method, recovery period and convention IRC § 168 prescribes in that year^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(b)(1), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(b)(1)).

Loss on a later sale. a loss on the sale of a former personal residence is allowed where the property was rented or otherwise appropriated to income-producing purposes before the sale and so used up to the time of sale^TY2026Verified 2026-08-21Reg. § 1.165-9(b)(1), opened at law.cornell.edu/cfr/text/26/1.165-9 (Reg. § 1.165-9(b)(1)), measured by the basis for determining loss on a later sale is the lesser of the fair market value at the time of conversion or the adjusted basis for loss at that time, in each case adjusted for the period after the conversion^TY2026Verified 2026-08-21Reg. § 1.165-9(b)(2), opened at law.cornell.edu/cfr/text/26/1.165-9 (Reg. § 1.165-9(b)(2)).

Casualty on converted property. for a casualty loss on converted property, the fair market value on the date of conversion, if less than the adjusted basis at that time, is used as the basis for determining the amount of the loss^TY2026Verified 2026-08-21Reg. § 1.165-7(a)(5), opened at law.cornell.edu/cfr/text/26/1.165-7 (Reg. § 1.165-7(a)(5)).

Conversion the other way. a conversion of MACRS property to personal use is treated as a disposition in that year for depreciation purposes, but no gain, loss or IRC § 1245 or § 1250 recapture is recognised on it — those provisions apply instead to any later disposition of the converted property^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(c), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(c)).

Gain is not capped. No provision limits the basis for determining gain on converted property, so the original adjusted basis, reduced by depreciation taken after the conversion, governs a sale at a profit.

Current figures

How it works in practice

Three figures, and they are computed separately. On a conversion into business use the property may carry:

• a depreciation basis — where property not previously used in a trade or business or held for the production of income is converted to such use, the fair market value on the date of conversion, if less than the adjusted basis at that time, is the basis for computing depreciation^TY2026Verified 2026-08-21Reg. § 1.167(g)-1, opened at law.cornell.edu/cfr/text/26/1.167(g)-1 (Reg. § 1.167(g)-1), the lesser of adjusted basis and fair market value at conversion;
• a basis for determining loss — the basis for determining loss on a later sale is the lesser of the fair market value at the time of conversion or the adjusted basis for loss at that time, in each case adjusted for the period after the conversion^TY2026Verified 2026-08-21Reg. § 1.165-9(b)(2), opened at law.cornell.edu/cfr/text/26/1.165-9 (Reg. § 1.165-9(b)(2)), the same lesser figure, adjusted for depreciation taken since;
• a basis for determining gain — the original adjusted basis, adjusted for depreciation taken since, with no cap at all.

Where fair market value at conversion exceeded adjusted basis, all three collapse into one figure and there is nothing to keep apart. The divergence arises only where the property had fallen in value before the conversion, which is precisely when a taxpayer is most likely to convert.

The consequence is a dead zone. Sell for more than the gain basis and there is a gain; sell for less than the loss basis and there is a loss; sell between the two and there is neither. This is the same structure as the gift rules in IRC § 1015(a), reached by a different route and for the same reason — the taxpayer should not be able to convert a personal loss into a deductible one by changing the use of the asset.

Depreciation starts fresh. on a conversion to business or income-producing use, depreciation for the year of change and later years is determined as though the property were placed in service on the date of the conversion, using the method, recovery period and convention IRC § 168 prescribes in that year^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(b)(1), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(b)(1)). The property is treated as placed in service on the date of conversion, so it gets the full recovery period IRC § 168 prescribes for it in that year, using that year’s conventions and any elections the taxpayer makes then. Its age in the taxpayer’s hands is irrelevant, and so is any depreciation the taxpayer could not take while it was personal.

Which means the property is new for other purposes too. Because the conversion date is the placed-in-service date, the property is tested against the bonus depreciation and IRC § 179 rules in force that year — subject, for bonus depreciation, to the acquisition requirements, which a taxpayer’s own long-held property will not meet.

Converting out is a disposition for depreciation and nothing else. a conversion of MACRS property to personal use is treated as a disposition in that year for depreciation purposes, but no gain, loss or IRC § 1245 or § 1250 recapture is recognised on it — those provisions apply instead to any later disposition of the converted property^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(c), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(c)). Depreciation stops, computed for the year of change on a fractional basis, but “no gain, loss, or depreciation recapture under section 1245 or section 1250 is recognized.” The recapture potential does not disappear — the regulation says expressly that those provisions “apply to any disposition of the converted property by the taxpayer at a later date.” A business that converts a vehicle to personal use has deferred the recapture, not escaped it.

A casualty on converted property uses the same cap. for a casualty loss on converted property, the fair market value on the date of conversion, if less than the adjusted basis at that time, is used as the basis for determining the amount of the loss^TY2026Verified 2026-08-21Reg. § 1.165-7(a)(5), opened at law.cornell.edu/cfr/text/26/1.165-7 (Reg. § 1.165-7(a)(5)). This sits alongside the ordinary Reg. § 1.165-7(b)(1) rule, so the loss is the lesser of the decline in value and a basis that is itself the lesser of two figures.

How this has changed

None of the regulations on this page has been amended in the period covered by current legislation, and nothing in Pub. L. 119-21 touches them. Reg. § 1.167(g)-1 dates from 1960 and Reg. § 1.165-9 from the same era; Reg. § 1.168(i)-4 was issued in 2004 to give the change-of-use rules a home under the modern cost recovery system.

What has changed is how often the conversion-out rule matters. Because expensing and bonus depreciation now write most business personal property off immediately, a business that later converts an asset to personal use has taken the whole deduction and has a nil basis. The regulation recognises nothing at the conversion, so the entire recapture waits for a sale that may be years away and may never happen if the asset is scrapped. Reg. § 1.168(i)-4(c) has not changed; the amounts riding on it have grown by an order of magnitude.

One drafting point worth knowing. Reg. § 1.165-9 is headed “Sale of residential property” and its paragraph (b) speaks of a property “purchased or constructed by the taxpayer for use as his personal residence.” The rule it states is applied more widely than its heading suggests — the same lesser-of measure appears in Reg. § 1.165-7(a)(5) for casualties and in Reg. § 1.167(g)-1 for depreciation, neither of which is confined to residences. A reader looking for the loss rule for a converted non-residential asset will not find it in a section with that heading, and the principle is the same.

Exam focus

Ask which direction the conversion went. Into business use, and the question is about three bases and a fresh recovery period. Out of business use, and the answer is that nothing is recognised now and everything is recognised later.

For a conversion in, compare fair market value at conversion with adjusted basis. If value is lower, expect a question that turns on the dead zone between the gain and loss bases.

Know that the conversion date is a placed-in-service date, so the recovery period starts fresh — but that it is not an acquisition, so bonus depreciation and expensing are unavailable.

Finally, remember that recapture survives a conversion to personal use and lands on the later disposition.

Check yourself

1. A taxpayer converts a residence with a $400,000 adjusted basis to a rental when it is worth $300,000. What is the basis for depreciation?

Answer: $300,000, allocated between building and land. where property not previously used in a trade or business or held for the production of income is converted to such use, the fair market value on the date of conversion, if less than the adjusted basis at that time, is the basis for computing depreciation^TY2026Verified 2026-08-21Reg. § 1.167(g)-1, opened at law.cornell.edu/cfr/text/26/1.167(g)-1 (Reg. § 1.167(g)-1) — the fair market value at conversion, being less than the adjusted basis, is the basis for computing depreciation.

2. After $40,000 of depreciation she sells the property for $290,000. What does she report?

Answer: Nothing. the basis for determining loss on a later sale is the lesser of the fair market value at the time of conversion or the adjusted basis for loss at that time, in each case adjusted for the period after the conversion^TY2026Verified 2026-08-21Reg. § 1.165-9(b)(2), opened at law.cornell.edu/cfr/text/26/1.165-9 (Reg. § 1.165-9(b)(2)) gives a loss basis of $300,000 less $40,000, or $260,000, and the gain basis is $400,000 less $40,000, or $360,000. A sale at $290,000 is above the first and below the second, so there is neither gain nor loss.

3. A business converts a fully depreciated machine to the owner’s personal use. What is reported in that year?

Answer: Nothing. a conversion of MACRS property to personal use is treated as a disposition in that year for depreciation purposes, but no gain, loss or IRC § 1245 or § 1250 recapture is recognised on it — those provisions apply instead to any later disposition of the converted property^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(c), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(c)) — the conversion is a disposition for depreciation purposes only, and no gain, loss or IRC § 1245 or § 1250 recapture is recognised on it. The recapture applies to any later disposition of the converted property.

4. May a taxpayer claim bonus depreciation on property converted from personal to business use?

Answer: No. The conversion gives a placed-in-service date under on a conversion to business or income-producing use, depreciation for the year of change and later years is determined as though the property were placed in service on the date of the conversion, using the method, recovery period and convention IRC § 168 prescribes in that year^TY2026Verified 2026-08-21Reg. § 1.168(i)-4(b)(1), opened at law.cornell.edu/cfr/text/26/1.168(i)-4 (Reg. § 1.168(i)-4(b)(1)) but not an acquisition, and IRC § 168(k)(2)(E)(i) requires that the property was not used by the taxpayer before the acquisition. IRC § 179 likewise requires property acquired by purchase.

5. Property worth more than its adjusted basis is converted to business use. How many bases does it have?

Answer: One. The cap in where property not previously used in a trade or business or held for the production of income is converted to such use, the fair market value on the date of conversion, if less than the adjusted basis at that time, is the basis for computing depreciation^TY2026Verified 2026-08-21Reg. § 1.167(g)-1, opened at law.cornell.edu/cfr/text/26/1.167(g)-1 applies only where fair market value at conversion is less than adjusted basis, so where value is higher the depreciation basis, the gain basis and the loss basis are all the adjusted basis.