Determining Your Home's Tax Basis

Determining Your Home's Tax Basis

If you are a homeowner, "basis" is a word you must understand. The basis is the value of your home (or other property) for tax purposes. When you sell your home, your profit or loss for tax purposes is determined by deducting the basis sale price from the date of the sale (plus selling costs, like real estate costs): the higher your basis, the lower your profits, the lower your tax liability. If you sell the assets for less than the basis, you will lose money. However, losses incurred by the sale of a personal residence are not deductible. 

One thing that confuses people about the basis is that it can change over time. When this happens, your basis is called an "adjusted basis." To determine the basis value, start with the original basis, then add or subtract the necessary changes.

Cost Basis

If you have purchased your home, the starting point for establishing the basis for the property is the amount you paid. Of course, this is called a cost basis. Your basis price is the purchase price, plus other expenses. Use the total purchase price as a starting point, regardless of how you pay for the property, cash, or loan. If you buy a property and accept an existing mortgage, use the amount paid for the property, plus the amount you still have to pay for the mortgage.

Example: Matt buys his house for $ 50,000 in cash and takes out a mortgage for $ 200,000. The starting point for determining Matt's basis is $ 250,000.

Certain taxes and other expenses that you pay when you buy a home are added to your property basis. Most of these charges should appear on the statement you receive after the property filing closes. However, some may not appear here, so be sure to check your records to see if you have made any other payments that need to be added to the property basis. This includes property taxes owed by the seller that you pay, liquidation fees, and other fees, such as property insurance.

When Cost Is Not The Basis

You cannot use cost as a starting point for a house you received as an inheritance or gift. The basis of inherited property is typically the fair market value of the property at the time of the owner's death. Thus, if you keep your leased property until death, your heirs can resell it and pay little or no tax.

Example: Matt inherits the house from his deceased parents. The property's fair market value is $ 200,000 at his parent's death. This is Matt's basis. He sells the property for $ 220,000. His total sales taxable profit is only $ 20,000.

The basis for a house or other property received as a gift is the adjusted basis held by the donor at the time of the donation.

If you are building your house, the starting point is the cost of construction. The cost includes the cost of equipment, materials, and labor. However, it is not possible to add the cost of labor to the basis of the property. Add the interest you pay on building loans during the construction period but deduct the interest you pay before and after building as an operating expense.


Adjusted Basis

As stated above, the basis of the property is not fixed. It changes with time to reflect the true value of your investment. This new basis is called an adjusted basis because it reflects the adjustments in its original basis.

Discount on the Basis

The original basis must be reduced by items that epitomize a return of your cost. These include:

  • Any amount received for granting an easement.

  • Any deductible accident claims not covered by insurance

  • Depreciation permit or permit if you have used part of your home for business or rental purposes

  • Profit from the sale of an old house before May 7, 1997

  • The amount of any insurance or other payment received as a result of an accident or theft

Basis Increases

It would help if you increased the basis of any property if:

  • Amounts spent to restore property after it has been damaged or lost due to theft, fire, flood, storm, or other casualties

  • Legal costs associated with the property, such as defense costs and title improvement.

  • Tax credits received after 2005 for internal energy improvements

  • The cost of any addition or improvement

  • The cost of extending service lines to the property

Additionally, assessments should be added for items that increase your property's value, such as streets and sidewalks. For example, if your city puts curbs on the road in front of your rented house and estimates the cost for you, you need to add that value to your property.

The most common way for homeowners to grow their basis is to improve their homes. Upgrades include any work done that adds value to your home extends its useful life, or makes it suitable for new uses. This includes room additions, new bathrooms, hallways, sidewalks, landscaping, electrical upgrades, kitchen renovations, decks, fences, plumbing renovations, new roofs, etc.

However, the adjusted basis does not include the cost of any upgrades that were subsequently removed from the house. For example, if you installed a metal fence some years ago and then replaced it with a redwood fence, the old fence's cost will no longer be part of your home's basis.

How is the basis cost of properties calculated?

If you own a property that needs to be accounted for on your return, a tax preparer can help you understand how to calculate your property's basis cost. First and foremost, it's important to know that the basis is the value of your equity investment in a property and is used for tax purposes. To find the adjusted basis:

  • Start with the initial real estate investment.

  • Add the cost of major upgrades.

  • Reduce the allowable amount of impairment losses and losses caused by accidents and theft.

How to determine the initial investment in the property

How to determine the initial investment in the property can vary. In most cases, the basis is the cost of the asset. The cost includes sales taxes and other purchase costs. Consider the list below for other cases and how to calculate the basis cost of your real estate.

  • For inherited assets, the basis is the fair market value (FMV) at death.

  • For gifted property, the basis depends on any profit or loss on the good's sale: 

If there is a profit, the basis is the adjusted donor basis. 

In the event of a loss, the basis is the lesser of the donor's adjusted basis or fair market value at the donation time.

  • For properties that have shifted from personal to commercial use, the basis used to calculate depreciation (i.e., depreciable basis) is usually the adjusted basis or fair market value of the property at the time of conversion. When you sell the property, the basis mentioned in the tax return depends on whether the property was sold for profit or loss:

In the case of profit, the basis is the adjusted basis when you sell the property.

When there is a loss, the basis for calculating the allowable loss is the lesser of the adjusted basis or the remaining depreciable basis (i.e., Fair market value at the time of conversion for further use.).

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