What does “Cost basis” mean in real estate?
Cost basis in real estate is the original value or purchase price of a property plus certain acquisition costs, used for tax purposes to determine gain or loss when the property is sold. Over time that basis can be increased by qualifying capital improvements or reduced by items such as depreciation and casualty reimbursements, producing an adjusted cost basis that is used to calculate taxable gain.
Key components of cost basis
- Original purchase price — the amount paid to acquire the property.
- Acquisition-related costs — closing fees and other expenses added to basis (title insurance, legal fees, loan fees, transfer taxes, recording fees, survey costs). See closing costs.
- Capital improvements — qualifying expenditures that add value or extend the property’s life (for example, adding a room, remodeling a kitchen, or replacing a roof).
- Subtractions — items that reduce basis, such as depreciation taken on rental or business property, insurance or casualty reimbursements, and certain casualty or theft losses. See depreciation.
Why cost basis matters
- It determines the capital gain or loss on sale: gain = sale price − adjusted cost basis.
- It directly affects how much capital gains tax you may owe.
- Accurate basis records help avoid overpaying taxes by ensuring you include acquisition costs and improvements and correctly subtract allowable deductions like depreciation.
Real-world examples
1. Homeowner example
Michelle bought a home for $180,000, paid $6,000 in closing costs, added a $50,000 mother-in-law suite, and received a $10,000 insurance payment for a roof replacement.
Cost basis = $180,000 + $6,000 + $50,000 − $10,000 = $226,000.
2. Investor example
Richard purchased a rental for $500,000 and used straight-line depreciation over 27.5 years (annual depreciation ≈ $18,181). After 15 years total depreciation is 15 × $18,181 = $272,715.
Adjusted cost basis = $500,000 − $272,715 = $227,285.
3. Gifted property example
Isaiah received a lake house as a gift. The original purchase price (donor’s basis) was $215,000, plus $6,450 in closing costs and $20,000 in improvements. Isaiah’s basis is the donor’s adjusted basis:
Basis = $215,000 + $6,450 + $20,000 = $241,450.
Practical application & tips
- Initial cost basis = purchase price + allowable acquisition fees. Keep all closing statements and receipts.
- Track capital improvements separately — they increase basis and reduce taxable gain when selling.
- For rental or business property, track depreciation taken each year because it reduces basis and may be subject to recapture.
- On sale, subtract adjusted basis from sale price to compute taxable gain; accurate records minimize tax liability and support positions in an audit.
- When receiving property by gift or inheritance, special rules apply to determine basis — use the donor’s or the fair market rules as appropriate.
Careful documentation of purchase costs, closing fees, and improvement invoices is essential to calculate and defend your cost basis when reporting sales on your tax return.
