What Is Adjusted Basis in Real Estate?
Adjusted basis is the original cost of a property adjusted up or down for certain events and expenses that occur while you own it. It’s the figure you use to determine your taxable capital gain or loss when you sell a property.
Why Adjusted Basis Matters
- Tax calculation: Sale price minus adjusted basis = capital gain or loss.
- Tax savings: A higher adjusted basis reduces taxable gain.
- Record keeping: Accurate basis records help avoid overpaying taxes and simplify reporting.
How Adjusted Basis Is Calculated
Basic formula: Adjusted Basis = Original Purchase Price + Capital Improvements − Depreciation − Casualty Losses
Components Explained
- Original purchase price: What you paid for the property plus acquisition costs (closing costs, transfer taxes, etc.).
- Capital improvements: Major, value‑adding work (roof replacement, additions, full kitchen remodel). Routine repairs do not count.
- Depreciation: For rental or business property, allowable annual depreciation reduces basis. (See depreciation.)
- Casualty losses: Unreimbursed damage from events like storms or fire that decrease basis.
Real-World Examples
Example 1 — Homeowner Selling a Primary Residence
- Purchase price: $300,000
- Closing costs: $6,000
- Capital improvements: $20,000 (HVAC + roof)
- Casualty loss: $5,000 (not covered by insurance)
Calculation: Original basis = $300,000 + $6,000 = $306,000 → + improvements = $326,000 → − casualty = $321,000. Adjusted basis = $321,000. If sale price = $400,000, gain = $79,000. If homeowner qualifies for the primary residence exclusion, up to $250,000 ($500,000 married) of gain may be excluded.
Example 2 — Rental Property Investor
- Purchase price: $1,500,000
- Closing costs: $10,000
- Capital improvements: $50,000
- Depreciation claimed: $400,000
- Previously deferred gain: $200,000
Calculation: Original basis = $1,510,000 → + improvements = $1,560,000 → − depreciation = $1,160,000 → − deferred gain = $960,000. Adjusted basis = $960,000. If sale price = $1,200,000, taxable gain = $240,000. Note: depreciation recapture may apply and is taxed at ordinary income rates; see depreciation recapture.
Example 3 — Inherited Property
- Fair market value at date of death: $500,000 (step‑up in basis)
- Capital improvements: $30,000
- Depreciation claimed previously: $100,000
Calculation: Original (stepped‑up) basis = $500,000 → + improvements = $530,000 → − depreciation = $430,000. Adjusted basis = $430,000. If sale price = $600,000, taxable gain = $170,000. The step‑up in basis at death often reduces tax liability compared with the decedent’s original purchase price.
Practical Tips
- Keep detailed records of purchase documents, closing statements, receipts for improvements, and insurance claims.
- Separate routine repairs from capital improvements—only the latter increase basis.
- If you own rental property, track annual depreciation precisely; unclaimed depreciation still affects future basis.
- Consult a tax professional for complex situations (like 1031 exchanges, deferred gains, or large casualty losses).
Bottom Line
Adjusted basis is a fundamental tax measure in real estate. Knowing how to calculate it—and keeping solid records of everything that affects it—helps you accurately compute gains or losses and minimize taxes when you sell. If you’re unsure about specifics, particularly depreciation or recapture rules, get professional tax guidance.
