Please see for reference
§ 1.167(g)–1 Basis for depreciation. - http://edocket.access.gpo.gov/cfr_2011/aprqtr/pdf/26cfr1.167(g)-1.pdf
The basis upon which the allowance for depreciation is to be computed with respect to any property shall be the adjusted basis provided in section 1011 for the purpose of determining gain on the sale or other disposition of such property. In the case of property which has not been used in the trade or business or held for the production of income and which is thereafter converted to such use, the fair market value on the date of such conversion, if less than the adjusted basis of the property at that time, is the basis for computing depreciation
So your cost basis in the property is your original purchase price $405,000 plus $15,000 in improvements = $420,000.
When the property was converted from rental to personal - its FMV was $206,000 plus land.
Because that value is less that the adjusted basis of the property at that time - the FMV should be used for depreciation.
So you should keep track of two basis.
1. $420,000 - $161,000 - $10,000 (cancellation of debt) - $1,710 (depreciation) = $247290
2. $206,000 plus $50,000(land) - $161,000 - $10,000 (cancellation of debt) - $1,710 (depreciation) = $83290
When the property is sold for $175,000 - you need to use the first basis to determine the gain and the second to determine the loss - so you have neither gain nor loss.
In additional - you may deduct previously disallowed passive losses $2,700.
Sorry for confusion.