What Is Adjusted Basis for Tax Purposes?
Adjusted Basis Involves Adding and Subtracting Certain Costs and Factors
The adjusted basis of an asset is its cost after you've adjusted for various tax issues. This is often a good thing because the higher your basis in an asset, the less you'll pay in capital gains tax when you sell it. Of course, it can work the other way, too. Just as some adjustments can increase your basis in an asset, others reduce it and this generally is not a good thing at tax time. You'll pay capital gains tax or have a capital loss based on the difference between your adjusted basis and the amount for which you sell the asset.
How to Calculate Adjusted Basis
Calculating adjusted basis in an asset begins with its original purchase price. You can increase your basis from there by adding on the amount of money you've spent improving the asset, as well as by amounts you might have paid for legal fees or selling costs.
Your basis decreases if you must subtract amounts that you previously claimed as tax deductions, such as depreciation, casualty losses, or theft losses.
Here's an Example
Let's say 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. Your basis would be the amount of money you initially paid for the property. You can then add to this the cost of any capital improvements you might have made to it, as well as agent commissions and other costs of sale.
But you're not done yet. If you've been depreciating the property on your tax returns since you've owned it, you must effectively recapture those deductions by subtracting them from your basis after you've added in the above costs.
Below are the key components of basis calculations, as well as what items can be added to achieve adjusted basis and what must be subtracted.
The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, other property, or services. Your cost also includes amounts you pay for the following items:
- 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
Source: cost basis section of Pub. 551.
Increases to Basis
Increase the basis of any property by all items 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. If you have to recapture any of the credit, increase your basis by the recaptured amount.
If you make additions or improvements to business property, keep separate accounts for them. Also, you must depreciate the basis of each according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. For more information, see Publication 946.
The following items increase the basis of property:
- 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
The following are some items that reduce the basis of property:
- 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
Source: adjusted basis section of Pub. 551.
The IRS discusses basis and adjusted basis in detail in Publication 551, Basis of Assets.
Note: Always consult with a tax professional for the most up-to-date information and trends. Tax laws and rules can change periodically. This article is not tax advice and it is not intended as tax advice.