Tax Basis in Real Estate Part III
In Part I of this series, I explored the definitions of Cost Basis and Adjusted Basis as they related to real estate investments. In Part II, we explored the types of costs included in the original Cost Basis. In this third and final article, we’ll look at what types of costs and expenses can affect the Adjusted Basis.
According to the IRS, “Before figuring gain or loss on a sale, exchange, or other disposition of 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 is the adjusted basis” (1) Over time, these adjustments can become significant so it's important to keep accurate records.
Increases to Basis
- Capital improvements - generally, the costs of any improvements having a useful life of more than one year are added to the cost basis. However, costs that have been deducted as current expenses such as amounts paid for incidental repairs or routine maintenance are not added. Improvements include any work done that adds to the value of property, increases its useful life, or adapts it to new uses. These include room additions, new bathrooms, decks, fencing, landscaping, wiring upgrades, walkways, driveway, kitchen upgrades, plumbing upgrades, and new roofs. But be aware that adjusted basis does not include the cost of improvements that were later removed. For example, if you built a deck on your property 15 years ago and then replaced it with a pool, the cost of the deck is no longer part of your home's adjusted basis.
- Assessments for local improvements – you can increase the basis of your property for any assessments for items such as paving roads, building ditches, installing sidewalks, bike paths, or sound barriers that increase the value of the property. Do not deduct them as taxes paid. You can, however, deduct as taxes charges for maintenance, repairs or interest charges related to these improvements.
- Casualty losses - these are amounts spent to restore property after it is damaged or lost due to theft, fire, flood, storm, or other casualty
- The cost of extending utility service lines to the property
- Impact fees
- Legal fees, such as the cost of defending and perfecting title
- Zoning costs
Decreases to Basis
- Depreciation – decreases the basis of property by the depreciation you deducted, or could have deducted, on your tax returns. Depreciation should be calculated for each year you owned the property and the cumulative amount is used to reduce your basis. For information on figuring depreciation, see IRS Pub. 946.
- Cancelled debt – although debt cancelled or forgiven is usually included in your gross income for tax purposes, there are situations where the cancelled debt can be excluded from income. In these cases, the amount of cancelled debt that has not been included in income must be used to reduce your basis in the property.
- Postponed gain from sale of property – if you have previously deferred capital gains using a 1031 exchange, the amount of gain deferred reduces your basis in the replacement property.
- Casualties and thefts – if you have a casualty or theft loss, it decreases the basis in your property by any insurance or other reimbursement and by any deductible loss not covered by insurance.
- Subsidies for Energy Conservation – generally, any subsidy you received from a public utility company for the purchase or installation of any energy conservation measure can be excluded from your gross income. To the extent these amounts have been excluded from your income, they must be used to reduce your basis.
- Easements – any amounts you receive for granting an easement on your property are used to reduce your basis.
- Rebates – any rebates treated as an adjustment to the sales price at closing.
|Increases to Basis||Decreases to Basis|
Assessments for local improvements:
Legal feesZoning costs
Deferred capital gains from prior 1031 exchange(s)
Proceeds received from partial takings via condemnation or the granting of easementsCasualty or theft loss deductions and insurance reimbursements
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*Realized 1031 is not an Investment Adviser or CPA and does not provide investment or tax advice. Any information contained in the 1031 Investment Plan or other materials is for illustrative purposes only. Securities offered through the Realized Marketplace are exclusively through WealthForge Securities, LLC, a registered broker/dealer and member of FINRA/SIPC (“WealthForge”). Certain members of Realized are registered representatives of WealthForge.
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