What Types Of Costs Are Included In Adjusted Basis?

The concept of cost basis, or simply basis, is frequently used to understand taxes, amortization, depreciation, and other issues impacting real estate investments. This is because understanding the basis of an investment—in other words, what you paid for it, plus purchase-specific expenses—can impact your overall investment strategy. 

When selling that asset, cost basis comes into play. So does the adjusted basis. In fact, understanding what expenses and costs fall under the adjusted basis category can help you potentially save taxes on capital gains resulting from the sale of your investment real estate.

A Review of the Adjusted Basis

Similar to cost basis, adjusted basis focuses on the original purchase price of a capital asset plus associated acquisition costs. But the adjusted basis includes additional costs associated with the investment during its hold, minus cumulative depreciation deductions claimed during the hold period. Also in this category are any previously deferred capital gains. 

As such, while the original cost basis is typically set in stone (in that it’s a set cost from the outset of the investment), the adjusted basis is, as suggested by its name, adjusted for certain events while you own that real estate asset. As such, it’s a fluid concept.

The IRS puts it more succinctly, stating that “Before figuring gain or loss on a sale, exchange or other disposition of a property, or figuring allowable depreciation, depletion or amortization, you must usually make certain adjustments to the basis of the property. The result of these adjustments to the basis is the adjusted basis.”

Adjusted Basis: Costs and Expenses

So, what are the IRS's "adjustments to the basis"? Under the adjusted basis category, there are increases and decreases to the basis. Let's look at these.

Increasing the Adjusted Basis

At the top of this list is any capital improvement made to your investment in real estate while you own it. Specifically, improvements that increase your property’s value or useful life, or that adapt it to new uses. This can include:

• Interior additions (room additions)
• Exterior work (adding fencing or decks, or improving landscaping)
• Property infrastructure (improving walkways, sidewalks, or driveways)
• Overall property improvements (plumbing or wiring upgrades)

There are additional expenses you can use to increase your basis, which are connected to capital improvements, such as the following:

• Utility service line extensions to your property
• Impact fees and zoning costs
• Some legal fees are involved with capital improvement issues
• Property restoration following casualty losses

Decrease on the Adjusted basis

Just as important as understanding capitalized costs added to your adjusted basis are the items that can reduce it. These include:

• Property depreciation
• Canceled debt not included in income
• Previously deferred, or postponed gain from a property sale (such as that used in a 1031 exchange)
• Insurance or other reimbursements for casualty or theft
• Energy conservation subsidies
• Amount received for easement grants
• Sales price rebates
  
  

The Importance of Adjusted Basis

Adjusted basis can help reduce taxes on your property’s capital gain when it’s time to sell. But not all costs related to your property can be used to boost it. It helps to understand that two common adjustments to basis are capital improvements (which increase the adjusted basis) and claimed depreciation (which reduces it). To obtain a clear picture of actions that can be applied to your adjusted basis, be sure to consult with your tax professional.