Example and Definition of Adjusted Basis
The adjusted basis of an asset is generally its purchase price plus capital improvements and costs of sale, less any tax deductions you previously took for the asset.
Calculating your adjusted basis in an asset begins with its original purchase price. The higher your basis, the less you'll pay in capital gains tax when you sell. Some adjustments can increase your basis in an asset, while others can reduce it, and the latter generally is not a good thing at tax time. You can increase your basis from there by adding the amount of money you've spent improving the asset, as well as any amounts you might have paid for legal fees or the costs of sale.
Your basis decreases if you must subtract amounts that you previously claimed as tax deductions, such as depreciation, casualty losses, or theft losses.
Suppose you purchase a piece of property for $100,000 with plans to renovate it and flip it for profit. However, shortly afterward, a crisis strikes, and you put off renovations. After a year, the house has depreciated in value by $5,000. The following year, you are able to put about $30,000 worth of improvements into the home, and you thus increase its value significantly. Your adjusted basis is now $125,000 ($100,000 - $5,000 + $30,000), which could result in a capital gains tax of $25,000 (were you to sell it), or the difference between the purchase price, and the final sale price, less the previous tax deduction.
Real property is not the only asset whose cost basis is subject to adjustment. So are securities, with events such as a stock split or dividends payment, that result in stock shares having an adjusted basis.
How Adjusted Basis Works
Your basis would be the amount of money you initially paid for the property, such as if you sell real estate that you didn't live in for the required number of years to allow you to qualify for a capital gains tax exclusion on its sale. You can then add the cost of any capital improvements you might have made, as well agent commissions and other costs of sale.
You must recapture any tax deductions that you previously took for the property by subtracting them from your basis after you've added in the above costs, such as if you've been depreciating the property on your tax returns since you've owned it.
How To Get Your Adjusted Basis
The key components of basis calculations are cost plus increases minus decreases. Some items can be added to achieve adjusted basis, and others must be subtracted.
The cost basis of property is usually its purchase price—the amount you paid in cash, debt obligations, other property, or services. Your cost also includes amounts you paid for:
- Sales tax
- Installation and testing
- Excise taxes
- Legal and accounting fees when they must be capitalized
- Revenue stamps
- Recording fees
- Real estate taxes if they're assumed for the seller
Increases to Basis
Increase the basis of property by all items that have been properly added to a capital account. These include the cost of any improvements that are expected to have a useful life of more than one year.
Rehabilitation expenses also increase basis, but you must subtract any rehabilitation credit allowed for these expenses before you add them to your basis. Increase your basis by the recaptured amount if you have to recapture any of the credit.
Keep separate accounts for each project if you make additions or improvements to a business property. You must also depreciate the basis of each according to the depreciation rules that would apply to the underlying property if you placed it in service at the same time you placed the addition or improvement in service.
Expenses that can increase the basis of property include:
- The cost of extending utility service lines to the property
- Impact fees
- Legal fees, such as the cost of defending and perfecting title
- Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements
- Zoning costs
- The capitalized value of a redeemable ground tent
Decreases to Basis
Some items reduce the basis of property. They include:
- Section 179 deduction
- Nontaxable corporate distributions
- Deductions previously allowed (or allowable) for amortization, depreciation, and depletion
- Certain vehicle credits
- Residential energy credits
- Postponed gain from sale of home
- Investment credit (part or all) taken
- Casualty and theft losses and insurance reimbursement
- Certain canceled debt adjustments to the sales price
- Rebates treated as adjustments to the sales price
- Gas-guzzler tax
- Adoption tax benefits
- Credit for employer-provided child care
- The adjusted basis of an asset is generally its purchase price plus capital improvements and costs of sale, less any tax deductions you previously took for the property.
- The higher your adjusted basis is, the less you’ll pay in the way of capital gains tax when you sell and realize a profit.
- You’re likely to have a capital loss if your adjusted basis is particularly high, and losses can be used to offset capital gains on other property.