Conversion of Personal to Rental Property

by John
(San Francisco, CA, USA)

Can you tell me how best to handle this situation? At the beginning of 2010 I bought a new home - and rather than sell my old home in this terrible market I am trying to hold on to it and rent it. The basic numbers are:

Jan/2005: Purchased 1st home for personal use at a price of $1,225,000,

Jan/2006: improvements 1st home of $25,000. Thus a cost basis of $1,250,000.

Jan/2010: Bought new home for personal use and moved in

Jan/2010: Conversion of 1st home to Rental Property, FMV at this time $1,000,000 - $1,100,000 (there are various studies I can use to justify a price at the lower or higher end of this range).

Feb/2010: Improvements to 1st home (now rental) since conversion: $40,000. New basis FMV + Improvements since conversion = $1,040,000 - $1,140,000.

2010: Rental losses $25,000 (income $35,000, expenses $60,000), not deductible because personal income is greater than $200,000

Future: Expect to continue rental loses for the foreseeable future

Questions:
1) I understand if I sell the first home for a loss I use the new basis which is lower than the original cost basis. How do I recoup the difference between the original cost basis and the new basis?
2) Is there a tax advantage to use the lower or higher new FMV estimate (I can justify either $1,000,000 or $1,100,000 as the post conversion starting basis) which one would be better to use?
3) Since I lived in the house for 5 years from 2005-2010, is there a reason I should sell the house before 2013 (so as to still have the ability to say I lived in it for 2 of the proceeding 5 years) ?
4) Because of my income I am not able to deduct the rental losses – am I able to recoup these loses somehow in the basis when I do sell it?
5) Any other ways to determine if I should sell now before incurring more rental loses, sell in the next 2 years before my live in for 2 of the last 5 years runs out, or hold on to it for as long as possible when hopefully I end up turning a profit?