What Types Of Costs Are Included In Adjusted Basis?

Posted by Drew Reynolds on Jul 1, 2022

Cost Calculation

The concept of cost basis, or simply basis, is frequently used when it comes to understanding taxes, amortizations, 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 it comes time to sell 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 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 affiliated acquisition costs. But the adjusted basis goes on to include additional costs involved 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, is 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 “adjustments to the basis” that the IRS talks about? Under the adjusted basis category, there are increases to the basis and decreases to the basis. Let’s take a closer look at these.

Increasing the Adjusted Basis

At the top of this list is any capital improvement made to your investment real estate while you own it. Specifically, improvements that increase your property’s value or its useful life, or that might 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 involved with capital improvement issues
  • Property restoration following casualty losses

Decrease to 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 with income
  • Previously deferred, or postponed gain from a property sale (such as that used with a 1031 exchange)
  • Insurance or other reimbursements for casualty or theft
  • Energy conservation subsidies
  • Amount received for easement grants
  • Sales price rebates

 

INCREASES TO ADJUSTED BASIS

Capital Improvements

  • Property additions
  • Roof replacement
  • Driveway replacement/repaving
  • HVAC installation
  • Property rewiring

Local Improvement Assessments

  • Water connections
  • Sidewalk and road upgrades
  • Miscellaneous
  • Repairing casualty losses
  • Legal fees
  • Zoning impacts

DECREASES TO ADJUSTED BASIS

  • Depreciation
  • Deferred capital gains (from previous 1031 exchanges)
  • Proceeds from partial taking via condemnation or easement granting
  • Reimbursements received or deductions taken from casualty or theft loss

 

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.


This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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