Understanding the adjusted basis of property is essential for determining the correct taxable amount when selling an asset, such as real estate. Calculating adjusted basis can seem complex, but by breaking down the process into simple steps, you can accurately determine the adjusted basis of your property.

What is Adjusted Basis?

The adjusted basis of a property is the original cost or value of an asset, which has been modified due to improvements, depreciation, or other factors that have an impact on its overall value. This value forms the basis for calculating capital gains or losses when an asset is sold.

Here’s how to calculate the adjusted basis of a property:

Step 1: Determine Original Basis

To establish the original basis of a property, consider the cost or value at which you acquired it, whether through purchase, inheritance, or as a gift.

For purchased assets: The purchase price typically forms the original basis. This includes any costs related to acquiring and closing on the property such as legal fees, real estate commissions, and settlement charges.

For inherited assets: The fair market value (FMV) of the property at the time of inheritance is generally used as its original basis.

For gifted assets: The donor’s adjusted basis becomes your original basis unless the FMV at the time of gifting is less than their adjusted basis. In that case, your basis would depend on whether you had gain or loss upon selling.

Step 2: Add Improvements

Any permanent improvements made to a property can increase its value and should be added to your original basis. Examples include adding a new room, upgrading wiring or plumbing systems, and installing central heating or air conditioning. The cost of these improvements should be accurately recorded and documented for accurate calculations.

Step 3: Subtract Depreciation

If you have claimed any depreciation on your property for tax purposes over time (such as with rental properties), this amount must be subtracted from the combined value of the original basis and improvements. Keep detailed records of depreciation claims to ensure the correct calculation of the adjusted basis.

Step 4: Account for Casualty Losses & Insurance Payouts

If you have experienced a casualty loss on your property (like damage from a storm, fire, or theft), any insurance proceeds or deductible losses can affect your adjusted basis. If you have used insurance proceeds to repair or rebuild your property, subtract that amount from the total cost of repairs or rebuilding. If insurance did not cover the loss and you claim it as a deductible loss, subtract that amount from your basis.

Step 5: Factor in Legal Fees & Commissions

If you have incurred any legal costs related to defending or perfecting title in the property, add these expenses to your basis. Also, include any commissions paid on the purchase or sale of the property to establish its ultimate adjusted basis.

By following these steps, you’ll arrive at an accurate adjusted basis for your property. This value is essential when determining capital gains tax liability during the sale of an asset, enabling you to make informed decisions about managing and maintaining your investments.