Determining Your Home's Tax Basis
Your tax basis in your home will be a key factor in calculating your tax gain or loss when you sell your home.
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If you're a homeowner, "basis" is a word you should understand. Basis is the amount your home (or other property) is worth for tax purposes. When you sell your home, your gain (profit) or loss for tax purposes is determined by subtracting its basis on the date of sale from the sales price (plus sales expenses, such as real estate commissions). The larger your basis, the smaller your profit will be, reducing your tax liability. If you sell your home for less than its basis, you'll have a loss. However, losses incurred on the sale of a personal residence are not deductible.
One confusing thing about basis is that it can change over time. When this occurs, your basis is called "adjusted basis." To determine the amount of your basis, you begin with your starting basis and then add or subtract any required adjustments.
If you’ve purchased your home, your starting point for determining the property’s basis is what you paid for it. Logically enough, this is called its cost basis. Your cost basis is the purchase price, plus certain other expenses. You use the full purchase price as your starting point, regardless of how you pay for the property—with cash or a loan. If you buy property and take over an existing mortgage, you use the amount you pay for the property, plus the amount that still must be paid on the mortgage.
Example: Jan buys her home for $60,000 cash and assumes a mortgage of $240,000 on it. The starting point for determining her basis is $300,000.
Certain fees and other expenses you pay when you buy a home are added to your basis in the property. Most of these costs should be listed on the closing statement you receive after escrow on your property closes. However, some may not be listed there, so be sure to check your records to see if you’ve made any other payments that should be added to your property’s basis. These include real estate taxes owed by the seller that you pay, settlement fees and other costs such as title insurance.
When Cost Is Not the Basis
You cannot use cost as the starting basis for a home that you received as an inheritance or gift. The basis of property you inherit is usually the property’s fair market value at the time the owner died. Thus, if you hold on to your rental property until death, your heirs will be able to resell it and pay little or no tax—the ultimate tax loophole.
Example: Victoria inherits her deceased parents' home. The property’s fair market value (excluding the land) is $300,000 at the time of her uncle’s death. This is Victoria’s basis. She sells the property for $310,000. Her total taxable profit on the sale is only $10,000 (her profit is the sales price minus the home's tax basis).
The basis of a home or other property you receive as a gift is its adjusted basis in the hands of the gift giver when the gift was made.
If you build your home yourself, your starting basis is the cost of construction. The cost includes the cost of materials, equipment, and labor. However, you may not add the cost of your own labor to the property’s basis. Add the interest you pay on construction loans during the construction period, but deduct interest you pay before and after construction as an operating expense.
Your basis in property is not fixed. It changes over time to reflect the true amount of your investment. This new basis is called the adjusted basis because it reflects adjustments from your starting basis.
Reductions in Basis
Your starting basis in your home must be reduced by any items that represent a return of your cost. These include:
- depreciation allowed or allowable if you used part of your home for business or rental purposes
- the amount of any insurance or other payments you receive as the result of a casualty or theft loss
- gain you posed from the sale of a previous home before May 7, 1997
- any deductible casualty loss not covered by insurance, and
- any amount you receive for granting an easement.
Increases in Basis
You must increase the basis of any property by:
- the cost of any additions or improvements
- amounts spent to restore property after it is damaged or lost due to theft, fire, flood, storm, or other casualty
- tax credits you received after 2005 for home energy improvements
- the cost of extending utility service lines to the property, and
- legal fees relating to the property, such as the cost of defending and perfecting title.
In addition, assessments for items that tend to increase the value of your property, such as streets and sidewalks, must be added to its basis. For example, if your city installs curbing on the street in front of your rental house, and assesses you for the cost, you must add the assessment to the basis of your property.
The most common way homeowners increase their basis is to make home improvements. Improvements include any work done that adds to the value of your home, increases its useful life, or adapts it to new uses. These include room additions, new bathrooms, decks, fencing, landscaping, wiring upgrades, walkways, driveway, kitchen upgrades, plumbing upgrades, new roofs.
However, adjusted basis does not include the cost of improvements that were later removed from the home. For example, if you installed a new chain-link fence 15 years ago and then replaced it with a redwood fence, the cost of the old fence is no longer part of your home's adjusted basis.
Example: Jane purchased her home for $200,000 and sold it ten years later for $300,000. While she owned the home, she made $50,000 worth of improvements, including a new bathroom and kitchen. These increased her basis to $250,000. She also received $10,000 in insurance payments one year to reimburse her for storm damage to the house. This payment decreased her basis to $240,000. She subtracts her $240,000 adjusted basis from the $300,000 sales price to determine her gain from the sale--$60,000.