Adjusted Cost Basis
Definition and meaning of Adjusted Cost Basis in real estate.
Adjusted cost basis is the net cost of a property for tax purposes, calculated as the original purchase price plus buying expenses and major capital improvements, minus any depreciation or casualty losses. This figure is used to calculate the taxable profit or loss upon the sale of the asset.
In more detail
Understanding adjusted cost basis is critical for homeowners and investors who want to minimize their capital gains tax liability. Capital improvements that increase the basis include additions, new plumbing, or landscaping, which are changes that add value or extend the property's useful life. Conversely, claiming depreciation on a rental property lowers the adjusted cost basis over time.
When the property is sold, the seller subtracts this adjusted basis from the sale price to determine the capital gain. Homeowners should consult a tax professional to ensure they categorize improvements and deductions correctly.
Key facts
| Category | Real Estate Investing |
|---|---|
| Purpose | Calculating taxable gain or loss at sale |
| Increased by | Title insurance, transfer taxes, and renovations |
| Decreased by | Depreciation deductions and casualty losses |
A homeowner sells their primary residence and calculates their adjusted cost basis by adding the original purchase price, closing costs, and the expense of a major kitchen remodel.
Frequently asked questions
What is the difference between a repair and a capital improvement?
Repairs maintain the home in its current condition and cannot be added to the basis, whereas improvements add value or extend the home's life and do increase the basis.
Does depreciation affect my adjusted cost basis?
Yes, depreciation deductions taken during property ownership decrease your adjusted cost basis, which can increase your capital gains tax when you sell.