Your basis in real estate is the value assigned to your property for tax purposes. It starts with your initial or cost basis—generally what you paid plus acquisition expenses—and is adjusted over time for improvements, depreciation and losses. Basis determines your taxable gain or loss when you sell or transfer the property.
Capital gain equals sale proceeds minus selling costs and your adjusted basis. A higher basis reduces your gain (and tax bill), while a lower basis increases it. Accurate cost basis ensures you only pay tax on real profit, not the full sale amount.
Your starting point is the actual purchase price. Market value only matters if you acquire property by inheritance or gift under special rules.
Include third‐party costs paid at closing: lender fees, title insurance, recording fees, transfer taxes, appraisals and legal charges. These are added to your purchase price to form your initial basis.
Seller credits reduce your acquisition costs and thus lower your basis. Earnest money simply prepayment of purchase price—only the net amount you actually pay at closing impacts basis.
Most residential rental property is depreciated over 27.5 years using the Modified Accelerated Cost Recovery System (MACRS). Commercial real estate uses a 39-year schedule.
Annual depreciation = (Adjusted basis at start of year × applicable MACRS percentage). Subtract each year’s depreciation to update basis for the next year.
When you sell, IRS “recaptures” depreciation at up to 25% tax rate. Recapture is calculated as the lesser of total depreciation taken or gain realized, then taxed separately from capital gains.
Inherited property generally receives a stepped-up basis equal to fair market value at the decedent’s date of death, minimizing capital gains if sold soon after.
For gifted property, the recipient’s basis is usually the donor’s adjusted basis. If FMV at gift date is lower and you later sell at a loss, special rules may apply using the FMV or donor’s basis, whichever yields lesser loss.
Transfers between spouses (or incident to divorce) carry over the transferor’s basis. No gain or loss is recognized, and the recipient inherits the original basis.
Keep purchase and sale closing statements, receipts for improvements, invoices, depreciation schedules, insurance claims and any correspondence affecting basis.
Report sales and basis calculations on Form 8949 and Schedule D for capital assets. Use Form 4797 for depreciable business property sales and recapture details.
Retain records at least three years after filing, or up to seven years if claiming large losses. For inherited or gift basis, keep originals indefinitely until property is sold.
Repairs keep property in ordinary operating condition (deductible as expenses, not added to basis). Capital improvements add value or prolong life and must be capitalized into basis.
Personal items removed at closing, HOA dues, rental security deposits, mortgage interest and property taxes are not basis adjustments.
Allocate basis between personal and business use based on square footage or fair rental value. In partnerships, each partner’s basis adjusts for contributions, allocated income, losses and distributions.
Sarah buys a rental home for $250,000 and pays $6,000 in closing costs. Initial basis: $256,000.
Adjusted basis at sale: $256,000 + 30,000 – 46,545 = $239,455.
If Sarah sells for $350,000 with $20,000 selling expenses, sale proceeds net $330,000. Taxable gain = $330,000 – 239,455 = $90,545.
Depreciation recapture: $46,545 taxed at up to 25%. Remainder ($90,545 – 46,545 = $44,000) taxed at long-term capital gains rates.
Your tax basis starts with your cost basis, increases for capital improvements and decreases for depreciation and losses—determining your taxable gain or loss.
