Posted by LLOYD J CAZES CPA

How to Properly Calculate Cost Basis for Real Estate

How to Properly Calculate Cost Basis for Real Estate

It’s important to learn how to calculate cost basis if you own a real estate business. Calculating your annual depreciation deduction requires the basis. It’s also needed when you sell the asset at a profit because your capital gains taxes are also calculated relative to your basis. 

Cost Basis Calculation

It’s relatively easy to calculate your cost basis at acquisition. You just need to first add up the price when you purchase it including both your down payment and the amount of your mortgage, as well as the closing costs that you paid to buy the property. Closing costs include fees for the legal, abstract, title insurance and title search fees, and taxes on transfer and seller expenses that you agree to pay. Your property insurance or the closing costs for your loan cannot be added. Your cost basis is the total.

How to Adjust Your Basis as the Property Owner

You can add the costs of any capital improvements that you make to the property, as you become the owner of it, to your cost basis to come up with an adjusted basis. Major expenditures that give the building a new or additional purpose or increase its value or its useful life is what capital improvements refer to.

The property’s basis must be increased by:

  • Any additions or improvements costs
  • Property restoration amounts after it is damaged or lost due to theft, fire, flood, or other casualties.
  • Tax credits that are given to you after 2005 for home energy improvements
  • The property’s Utility service line extension costs
  • Legal fees including the cost of defending and perfecting title relating to the property.

Furthermore, the property’s basis must be added with items that have been assessed and tend to increase the value of the property such as streets and sidewalks. For instance, your city installs curbing on the street in front of your rental house, and assesses you for the cost, the basis of your property must be added with the assessment.

How to Calculate Depreciation

Over a 39-year period, you are allowed to depreciate your commercial building. You only need to allocate the cost basis between the building and the land on which the building sits. The building’s basis must then be divided by 39 and claim that amount on both Form 4562 and your business or personal tax return. 

What You Need to Know About Selling, Capital Gains and Recapture Taxes

You subtract your adjusted cost basis from your net selling price when you sell the building. Your net selling price is what you sell the property for after closing costs and commissions. The profit that you gain, if you do have a profit, is subject to capital gains taxes. If your building is sold for more than the depreciated value or the adjusted cost basis less all the depreciation that you claimed as the building owner, Section 1250 recapture tax must also be paid by you on the difference between your depreciated value and the adjusted cost basis.

What You Should Know About 1031 Exchanges and Basis

You might complicate things if you bought your building through a section 1031 tax-deferred exchange because you just carried your old building’s basis forward. If there’s a $250,000 remaining basis to your old building and you sold it for $1,000,000, that money would only bring a $250,000 basis forward. If you bought a $1,500,000 building using the $1,000,000, you’ll get $750,000 as the new basis. The $500,000 of new money or debt that you put in produces the $500,000 of the basis. What carried forward on the $1,000,000 that you put into the exchange is the $250, 0000.

A couple of things to bear in mind. First, make sure you keep careful records of everything that goes into the calculation of your property’s basis. The IRS will want to see the substantiation of all the costs if you are ever audited. You never want to make any mistakes with taxes as you may end up paying more when it’s time to file your tax returns. Second, it may also be best to consult with a tax professional who can provide you the most up-to-date information and trends since tax laws and rules can change periodically. 

LLOYD J CAZES CPA
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