Calculating Your Home Sale Cost Basis

When selling your home, understanding its cost basis is important to determining your tax obligation. The basis is the value of your property for tax purposes, representing your total investment in the home. This figure is subtracted from the sale price to calculate your capital gain, which is the profit realized from the sale. A higher basis can lead to a smaller taxable gain, directly impacting the amount of tax you might owe.

Determining Your Initial Basis

Your initial basis is established at the time of purchase. The primary component of this initial basis is the contract price you paid for the home. This starting point remains the same whether you paid in cash, took out a mortgage, or assumed an existing mortgage. If you acquired the property through a mortgage, the full amount of the mortgage is included in this initial calculation.

Beyond the purchase price, certain settlement fees and closing costs paid at the time of acquisition are added to your initial basis. These includible expenses are detailed on your settlement statement, often a HUD-1 form for older purchases or a Closing Disclosure for more recent ones. Specific costs that can be added include:

• Abstract fees
• Charges for installing utility services
• Legal fees
• Recording fees
• Survey costs
• Transfer or stamp taxes
• Owner’s title insurance

Not all charges paid at closing can be included in your initial basis. Costs that are not part of acquiring the property itself must be excluded from the calculation. These non-includible expenses include fire or hazard insurance premiums, rent for occupying the home before closing, and charges for utilities or other services related to occupancy. These items are considered ongoing costs of homeownership and do not increase your investment in the property for tax purposes.

Adjustments That Increase Your Basis

Over the years of homeownership, you will likely make expenditures that increase your property’s basis, with the most significant being capital improvements. A capital improvement is an expense that adds substantial value to your home, prolongs its useful life, or adapts it to new uses. This is distinct from a simple repair, which merely maintains the home in its current condition. For example, replacing a single broken window pane is a repair, but replacing all the windows with new, energy-efficient models is an improvement.

Improvements are significant projects, such as adding a new room, finishing a basement, or installing a new deck. Other examples include paving your driveway, installing a new HVAC system, or putting on a new roof. In contrast, repairs like painting a room, fixing a leak, or patching a hole in the wall are considered routine maintenance and their costs are not added to your basis.

The Internal Revenue Service (IRS) provides guidance in Publication 523, “Selling Your Home,” which offers extensive examples to help homeowners make this distinction. You should save all receipts, contracts, and proof of payment for every capital improvement you make. These documents are the evidence needed to justify the additions to your basis when you eventually sell the property. Without proper documentation, you may not be able to claim these increases, potentially resulting in a higher taxable gain.

Other costs that can increase your basis include special assessments for local improvements, such as the cost of paving a city street or installing new water lines in your neighborhood. Amounts spent to restore your home after a casualty loss, to the extent they are more than any insurance reimbursement, also increase your basis. Legal fees related to the property, such as the cost of defending your title, can be added as well.

Adjustments That Decrease Your Basis

While many homeowners focus on additions to basis, certain events require you to decrease it. If you received tax credits for energy-efficient home improvements, the cost of the improvement that you add to your basis must be reduced by the credit amount. For example, if you spent $20,000 installing solar panels and received a $6,000 credit, you would add $14,000 to your basis.

Your basis must also be reduced for any insurance or other reimbursements you receive for casualty or theft losses. If your home was damaged and your insurance company paid for the repairs, your basis is reduced by the reimbursement amount. Similarly, if you received a payment for granting an easement or right-of-way on your property to a utility company or a neighbor, that payment decreases your basis.

Another scenario that requires a basis reduction is if you used a portion of your home for business or as a rental property and claimed depreciation deductions. The total depreciation you were allowed to take over the years must be subtracted from your basis. This is true even if you didn’t claim the full depreciation you were entitled to; the basis must be reduced by the amount that was allowable under the law.

Calculating Your Final Adjusted Basis and Gain

The calculation for your adjusted basis is to start with your initial basis, add the total cost of all your capital improvements and other increases, and then subtract the total of all decreases. Once you have the adjusted cost basis, you can calculate your capital gain. The formula for this is the home’s selling price, minus any selling expenses, and minus your adjusted cost basis.

Selling expenses are the costs associated with the sale, such as real estate agent commissions, advertising fees, legal fees, and seller-paid closing costs. These expenses reduce the amount you are considered to have realized from the sale.

Under current tax law, most homeowners can exclude a significant portion of this gain from their income. Single filers can exclude up to $250,000 of gain, and married couples filing jointly can exclude up to $500,000, provided they meet certain ownership and use tests. If your calculated gain is less than your available exclusion, you likely will not owe any federal income tax on the sale.