What “Adjusted cost basis” Means in Real Estate
Adjusted cost basis is the original purchase price of a property adjusted up or down for certain costs, improvements, deductions, and losses over time. It’s the figure the IRS uses to determine your taxable gain or loss when you sell real estate, so understanding how to calculate it can reduce surprise tax bills and help you make smarter selling or investment decisions.
Why adjusted cost basis matters
- Tax calculation: Capital gain or loss = Sale price − Adjusted cost basis. A higher adjusted basis generally means a smaller taxable gain.
- Investment planning: Knowing your adjusted basis helps you time sales, plan improvements, and manage depreciation strategies for rental property.
- Record keeping: Accurate basis records (receipts, invoices, closing statements) are essential when you sell.
How to calculate adjusted cost basis
Adjusted Cost Basis = Original Purchase Price + Capital Improvements − Depreciation − Casualty Losses − Other Deductions
Key components:
- Original purchase price: Amount you paid, including allowable acquisition costs (closing costs, title fees, recording fees).
- Capital improvements: Major, long-lasting upgrades that add value (e.g., room additions, new roof, major HVAC/plumbing/electrical work). These increase basis.
- Depreciation: For rental or business property, allowable annual depreciation deductions reduce basis. Depreciation recapture may apply when you sell.
- Casualty losses: Deductions for damage from events like storms or fires lower basis.
- Other deductions: Certain insurance reimbursements, tax credits taken, or deductible settlement amounts can also affect basis.
Practical examples
Example 1 — Homeowner with improvements
Sarah buys a house for $300,000 and pays $5,000 in closing costs. Over the years she spends $20,000 on a new kitchen and deck (capital improvements).
Adjusted cost basis = $300,000 + $5,000 + $20,000 = $325,000.
If she sells for $400,000, capital gain = $400,000 − $325,000 = $75,000.
Example 2 — Rental property with depreciation
John buys a rental for $250,000, makes $10,000 in improvements, and claims $50,000 in depreciation over a decade.
Adjusted cost basis = $250,000 + $10,000 − $50,000 = $210,000.
If he sells for $300,000, capital gain = $300,000 − $210,000 = $90,000. Note: the $50,000 of depreciation may be subject to depreciation recapture and taxed differently.
Example 3 — Casualty loss
Emily’s $200,000 home suffers storm damage. She spends $15,000 on repairs and claims a $10,000 casualty loss deduction.
Adjusted cost basis = $200,000 + $15,000 − $10,000 = $205,000.
Selling at $250,000 yields a capital gain of $45,000.
Key takeaways
- Keep detailed records of purchase costs, invoices for improvements, depreciation schedules, and any casualty loss documentation.
- Capital improvements increase your basis; routine repairs do not. Distinguish between the two when tracking expenses.
- Depreciation reduces basis for rental properties and can trigger recapture tax on sale — see depreciation.
- Casualty loss deductions lower basis — track insurance payouts and claims carefully.
- Because rules can be complex (especially for investment properties), consult a tax professional to confirm calculations and tax consequences.
Conclusion
Adjusted cost basis is a foundational tax concept in real estate: it defines the taxable portion of any sale. By tracking original purchase costs, qualifying capital improvements, depreciation, and deductible losses, you can calculate an accurate basis, minimize taxable gains where possible, and make informed decisions about selling or improving property.
