Real Estate Basis: How Is It Calculated?

Real Estate Basis: How Is It Calculated?

The word “basis” is commonly used among homeowners. It’s the amount of your home or other properties is worth for the purpose of taxes. The gain (profit) or loss you get from selling your home is calculated by subtracting its basis on the date of sale from the sales price including sales expenses (like real estate commissions). When your profit is small, your basis is larger and this reduces your tax liability. You’ll have a loss if your home is sold for less than its basis. However, you won’t be able to deduct the losses incurred on the sale of your personal residence.

The changes that happen over time with the basis is the main thing that confuses everyone. When this happens, your basis is called “adjusted basis”. In order to find out the amount of your basis, you start the calculation from your starting basis and adding or subtracting any adjustments required.

What is the Cost Basis?

What you paid for purchasing your home is the starting point for determining the property’s basis. This is called its cost basis as this is the kind of name that makes sense for this calculation. You add the purchase price with certain other expenses and you get the cost basis. Regardless of how you pay for your property (cash or loan), your starting point is always the full purchase price. You use the amount you pay for the property and add the amount that still must be paid on the mortgage in cases where you buy a property and take over the mortgage that already exists.

What happens when the cost is not the basis?

If you received a home as an inheritance or a gift, you are not allowed to use cost as the starting basis for that home. Whatever the property’s fair market value was at the time the owner died, will be used as the basis of property you inherit. It is, therefore, best to hold on to your rental property until death so that your heirs will be able to resell it and pay little or no tax.

The basis of a home or other property given to you as a gift is its adjusted basis in the hands of the person who gave the gift to you when the gift was made.

For those who build their home by themselves, the cost of construction is the starting basis. Some of these costs are materials, equipment, and labour. However, the cost of your own labour to the property’s basis may not be added. During the construction period, the interest being paid on construction loans can be added but as an operating expense, the interest that was paid before and after construction must be deducted.

Understanding the Adjusted Basis

To show the true amount of your investment, there will not be a fixed property basis. Since the adjustments from your starting basis will be reflected, the new basis will be called “adjusted basis”.

Reductions in Basis

Any items that represent a return of your cost must reduce your starting basis in your home and these items include:

  • If you used part of your home for business or rental purposes, depreciation allowed or allowable.
  • As a result of a casualty or theft loss, any insurance amounts or other payments.
  • If you sold a home before May 7, 1997, the gain you pose from the sale.
  • Any deductible casualty loss your insurance doesn’t cover.
  • Any amount you receive from the easement granting.

Basis Increases

Your property’s basis must be increased by:

  • Any additions or improvement costs
  • Amounts spent to restore property because of damaged or lost due to theft, fire, flood, storm, and other types of casualty.
  • Tax credits you got after 2005 for improvements on home energy.
  • The cost of extending utility service lines to the property, and
  • Property legal fees including the cost of defending and perfecting title.

If you’re a homeowner and you want to increase the basis of your property, it’s best to make home improvements. Any work done to add value to your home is called improvements, as well as anything that increases its useful life or adapts it to new uses. They can be room additions, new bathrooms, decks, fencing, landscaping, wiring upgrades, walkways, driveway, kitchen upgrades, plumbing upgrades, new roofs.

Note that the cost of improvements that were later removed from the home is not included in the adjusted basis. 

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