There can be significant unfavorable tax consequences to converting a primary residence to a rental. Too many people find out the consequences when it is too late. The time for understanding the consequences is before you consider converting the residence, not after. The consequences become greater the longer you have owned the residence and the more taxable gain or appreciation you have had on your property. The disadvantages of converting your residence to a rental when you have gains are more significant since the Taxpayers Relief Act of 1997.

1. Exclusions: One of the great tax benefits of home ownership if the opportunity to exclude up to $500,000 of taxable gain for married taxpayers and $250,000 for single taxpayers. However, should a homeowner decide to convert their residence to rental, those gains would remain with the property and be recognized when the rental is finally sold. In other words, you lose the opportunity to exclude those gains, which is a significant tax break for homeowners since the new Taxpayers Relief Act of 1997.
2. Tax Savings: Tax savings come from rental real estate through the non-cash deduction of depreciation or cost recovery. However, when you convert a residence, you may only depreciate the lower of your cost or basis; you will have a low basis, if you have large gains in the residence. A taxpayer would be better off to sell the residence and buy a rental property with a new basis if he wants to be in the rental property business.
3. Reinvestment Requirements: Should you convert your residence and then want to get your cash out in the future, you cannot sell the home to do so without paying the tax on the sale at that time. That certainly is not the case when you sell your residence. You are not obligated to reinvest any of the cash proceeds when you well your residence.