How to Determine the Basis of Your Property

Basis is the amount of your investment in a property for tax purposes. It is used to determine the capital gain or loss when you sell an asset. A higher basis can lead to a smaller taxable gain and a lower tax liability.

Basis is also used when calculating deductions for depreciation on business or rental property. The initial basis can change over the time you own the property, so understanding how it works is part of proper tax management.

Determining Your Initial Basis

The way you acquire a property determines the rules for its initial basis. This figure is the starting point for all future adjustments.

Purchased Property

When you purchase property, its initial basis is its cost. This includes the purchase price plus various acquisition expenses, such as settlement fees and closing costs. These can include:

• Abstract fees
• Charges for installing utility services
• Legal fees
• Recording fees
• Surveys
• Transfer taxes
• Title insurance

For example, if you buy a home for $400,000 and pay $4,000 in settlement costs like legal fees and title insurance, your initial basis is $404,000. This total investment is the figure used for future tax calculations.

Inherited Property

The basis of inherited property is its fair market value (FMV) on the date of the original owner’s death. This is often called a “stepped-up” basis because it increases to the current market value, which can eliminate income tax on appreciation that occurred during the decedent’s lifetime.

Fair market value is the price a property would sell for on the open market. For assets like real estate, the FMV is determined by a professional appraisal.

Gifted Property

For property received as a gift, the recipient’s basis is the same as the donor’s adjusted basis at the time of the gift. This is known as a carryover basis, meaning you inherit the property’s tax history.

An exception applies if you sell the gifted property for a loss. To calculate a loss, your basis is the lesser of the donor’s adjusted basis or the property’s FMV when the gift was made. For example, your uncle gifts you stock with his basis of $10,000, but its FMV is only $8,000. Your basis for calculating a future gain is $10,000. However, if you sell it for a loss, your basis is $8,000.

Property Received for Services

If you receive property as payment for your services, the transaction is taxable. The property’s fair market value (FMV) is considered income in the year you receive it. Your initial basis in that property is its FMV, the same amount you report as income.

Property Received in a Divorce

When property is transferred between spouses or former spouses as part of a divorce, no immediate tax is due. The recipient’s basis is the same as the transferor’s adjusted basis before the transfer. This is a carryover basis, where the recipient takes on the existing tax basis of the property.

Calculating Adjusted Basis

Your property’s basis is not fixed and changes over time. Events after the initial acquisition can increase or decrease your basis. The result of these changes is the “adjusted basis,” which is used for calculating gain, loss, or depreciation.

Increases to Basis

Certain costs increase your property’s basis. The most common are capital improvements, which are expenses that add value, prolong the property’s life, or adapt it to new uses. Examples include adding a room, installing a new roof, or paving a driveway.

Routine maintenance, like painting or fixing a leak, does not increase basis. Assessments for local improvements, such as new public sidewalks or utility lines, also increase your basis as they are considered capital investments.

Decreases to Basis

Some events decrease your basis. The depreciation deduction for business or rental property is a primary example. Depreciation is an annual deduction for wear and tear that directly reduces your basis.

Other items that decrease basis include insurance reimbursements for casualty or theft losses. Tax credits related to your property, such as residential energy credits, can also reduce your basis. For instance, taking a $1,000 energy credit requires you to reduce your home’s basis by $1,000.

For example, if a rental property has an initial basis of $300,000, you add a $50,000 renovation, and then claim $45,000 in depreciation, your adjusted basis becomes $305,000.

Required Documentation and Record-Keeping

Accurate records are necessary to prove your property’s basis to the Internal Revenue Service (IRS). You must keep documents that support the initial basis and all adjustments.

For purchased property, the final settlement statement, or Closing Disclosure, is the primary document. You should also keep receipts and contracts for any capital improvements.

If you inherit property, secure a copy of the estate tax return or a formal appraisal showing the property’s fair market value at the date of death. For gifted property, you need the donor’s records showing their original cost and any adjustments. Keep all records for as long as you own the property, plus at least three years after you sell it and file the tax return.

Special Considerations for Specific Assets

Certain assets have unique rules for calculating basis that can affect the tax outcome when they are sold.

Stocks and Securities

The basis of stocks or bonds is the purchase price plus any buying costs, like commissions. Reinvesting dividends to buy more shares increases your basis by the amount of the reinvested dividends.

During a stock split, your total basis does not change. You must reallocate your original basis over the new number of shares, which results in a lower basis per share.

Main Home

The basis of your main home is its cost plus improvements, minus any casualty losses or credits. A primary residence has a unique tax benefit called the main home sale exclusion.

If you meet ownership and use tests, you may be able to exclude a large amount of gain from your income when you sell. A single filer can exclude up to $250,000 of gain, while married couples filing jointly can exclude up to $500,000. Accurate basis tracking is still important to minimize any taxable gain that exceeds these exclusion amounts.