Sale proceeds and cost basis are numbers used when selling a home. Both are needed to calculate the amount an investor pockets from selling their real estate investment. We'll describe what both terms mean and how to apply them in practice.
Sale proceeds are the actual dollar amount from selling an investment property. For example, an investor buys a property for $300,000 and one year later sells it for $350,000. Their gross sales proceeds are $350,000. The $50,000 is a capital gain and taxable.
The above example is simplified. There is more to sale proceeds. Costs must also be factored in to get to what’s called net sale proceeds. Net sale proceeds are the amount an investor pockets after a sale but before taxes.
Some costs include:
If all costs add up to $25,000, then sale proceeds will come out to $50,000 - $25,000 = $25,000. Those costs don’t include capital gains taxes, which will subtract several thousand more dollars from the sale proceeds. Taxes aren’t factored into sale proceeds since they vary from investor to investor.
Mortgage interest costs that were paid while owning the investment are not part of the sale proceeds either.
To figure out your sale proceeds, the cost basis (or adjusted basis) of the property must be calculated. The cost basis is more than just the purchase price. It factors in other costs to create what’s called the adjusted cost basis.
The adjusted basis can be calculated as follows:
Purchase price
+ Acquisition cost (i.e., appraisal fees, attorney's fee, commission, credit report, document preparation fee, etc.)
+ Capital improvements
- Cumulative depreciation deductions
Let’s look at an example to see how these numbers work. An investor buys a house for $500,000. They have owned the house for five years. Their adjusted basis is:
$500,000
+ $10,000 (Acquisition cost)
+ $50,000 (Capital improvements)
- $91,750 (depreciation for five years)
= $468,250
The adjusted basis for this house is $468,250. If the investor sold the house for $650,000, their sale proceeds would be:
$650,000
- $45,000 (closing cost)
- $468,250
= $136,750
Sale proceeds for this house would equal $136,750, the amount the investor takes home before taxes.
If you're considering selling your real estate investment, it's best to work with a real estate accountant to understand your cost basis and potential sale proceeds.