How to Determine the Cost Basis of Your Home

When selling a home, its cost basis is the total investment used to calculate the capital gain—the profit—from the sale. A higher basis can reduce your taxable gain and lower your tax liability. The basis is not just the purchase price; it is adjusted over the time you own the property. For most homeowners, the gain on the sale of their primary residence is exempt up to certain limits, but a basis calculation is still needed to determine if any tax is owed.

Calculating Your Initial Basis

Your home’s initial basis starts with its purchase price, which is the amount you paid for the property. This figure is documented on your final closing statement.

Certain settlement fees and closing costs paid at purchase also increase your initial basis. These are expenses necessary to complete the property purchase. Includable costs from your settlement statement can include:

• Abstract fees
• Charges for installing utility services
• Legal fees
• Recording fees
• Surveys
• Owner’s title insurance

You can also add any back taxes or other debts the seller owed that you agreed to pay.

Conversely, some costs cannot be included in your initial basis as they relate to financing or occupying the home, not acquiring it. These expenses include:

• Fire insurance premiums
• Rent paid for occupying the home before closing
• Charges for utilities
• Fees associated with obtaining a mortgage, such as credit reports or loan assumption fees

Adjustments That Increase Your Basis

After the initial purchase, your home’s basis is increased by the cost of capital improvements. A capital improvement is a project that adds value to your home, prolongs its useful life, or adapts it to new uses, and must still be part of the property when you sell. These are distinct from routine repairs, which only maintain the property’s current condition.

For example, building an addition, finishing a basement, installing a new HVAC system, or replacing the entire roof are capital improvements. In contrast, repainting a single room or fixing a leaky faucet are classified as repairs, and their costs cannot be added to your basis. However, if repairs are completed as part of a larger renovation project, their costs may be includable.

Your basis also increases if you pay a special assessment tax for local improvements, such as new streets or sidewalks in your neighborhood. The costs to restore your property after damage from a casualty event, like a fire or storm, can also be added to your basis. Keeping detailed records and receipts for these expenditures is necessary to substantiate the increases.

Adjustments That Decrease Your Basis

Certain events require you to decrease your home’s basis. A primary reason for a decrease is claiming depreciation deductions. This happens if you have used a portion of your home for business, such as a home office, or if you have rented out part or all of the property. You must reduce your basis by the amount of depreciation you were allowed to take on your tax returns.

If you claimed a residential energy credit for energy-efficient improvements, your basis must be decreased by the amount of the credit. This prevents receiving a double tax benefit from the same expense. Your basis must also be reduced by any payment you receive for granting an easement on your property. It is also reduced if you receive an insurance reimbursement for a casualty or theft loss that is more than your cost to repair or replace the damaged property.

Special Circumstances for Acquiring a Home

The method of acquiring a home can alter how its initial basis is determined. If you inherit a home, the basis is the fair market value (FMV) of the property on the date of the previous owner’s death. This is known as a “stepped-up basis” and can be advantageous if the property has appreciated significantly.

If you acquire a home as a gift, your basis is the same as the donor’s adjusted basis when the gift was made, which is known as a “carryover basis.” A special rule applies if the home’s FMV is less than the donor’s adjusted basis when you receive it. In that case, the basis for calculating a future loss on a sale is the lower FMV.

If you build your own home, the initial basis is the total cost of construction. This includes the cost of the land, labor and materials, architect fees, building permits, and utility installation fees. You cannot include the value of your own labor in the basis calculation.

The Final Calculation and Required Documentation

The final step is to calculate the adjusted cost basis to determine your capital gain or loss. The calculation follows the formula: Initial Basis + Increases – Decreases = Adjusted Cost Basis. This figure represents your total investment in the property for tax purposes.

Meticulous record-keeping is required to support your figures. You should have the original closing statement for your initial basis, along with all receipts and contracts for capital improvements. For any decreases, you will need documentation such as past tax returns showing depreciation, records of insurance reimbursements, or forms showing energy credits claimed. Having this complete file of documents makes the final calculation straightforward and provides the necessary proof for your tax filing.