I purchased a house to be used as a second home in the beginning of 2005 and have my parents used it until May 2006. In June 2006 I converted it to a rental property and got a tenant in July. Around the same time I listed the property for sale and in mid-October I closed on the sale. The prices of the houses in NJ went down a lot from 2005 to 2006. Calculating the adjusted cost basis on the purchased and sale, i now have 35K losses . Here are my questions:
1) The fact that i have used the property as a rental property for 3.5 months, will i be entitled to all expenses associated with the rental property including depreciation, maintenance & repairs?
2) I owned the property for 22.5 months, of which 19 months as second home and the last 3.5 months as rental/investment property. Can i claim my huge loss on the sale of property ? WHich form should i use - form 4797 (Sale of Business Property) or Schedule D? I think if use schedule D, i won't be able to deduct the loss unless i have capital gains to offset which i don't. Is this a red flag to IRS that will increase the chances of me getting audited?

Thanks in advance for your help.