How To Calculate Cost Basis For Real Estate
The cost basis of a property has critical tax implications. Here’s an example to show how cost basis is calculated in the real world.
Let’s say that you purchase a property as a primary residence for a purchase price of $250,000. Over the years, you put in another $50,000 worth of home improvements, such as a new bathroom and kitchen. Those upgrades increased your adjusted basis to $300,000.
At some point, you put $5,000 of solar panels on the roof. But a tax credit of $5,000 made this transaction a wash in terms of cost basis. With these costs, your current cost basis is $300,000. After 10 years in the home, you decide to move on. The home fetches a selling price of $450,000.
When you sell, you gain $150,000 in profits. At tax time, you might be subject to capital gains tax on the profits. However, as a homeowner that has lived in the home for two of the last five years, you can exclude up to $250,000 of that gain from your income. This could be up to $500,000 if filing a joint return.
For the cost basis of your property, it’s a good idea to update the numbers regularly. When an expense impacts your cost basis, clearly document it for future reference. The IRS may need to see specific documentation for all transactions that lead to an adjusted cost basis when it’s time to calculate your capital gains tax obligations.
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