"Basis" is an important tax word that every homeowner should know. It simply means the monetary value of a property for tax purposes. To determine whether you realize a gain or incur a loss when you sell property, you subtract its basis from the sales price. Thus, the greater your basis, the less tax you'll have to pay when you sell your home.
You simply can't know whether you've had a gain or loss when you sell property unless you know its basis. For example, if your home has a $500,000 basis and you sell it for $750,000, you have realized a $250,000 gain. If you're a single taxpayer who qualifies for the $250,000 home sale exclusion, your entire gain is tax free. On the other hand, if your basis is $400,00, you'll realize a $350,000 gain on such a sale. $100,000 of your gain will be taxable.
So, do you know what your home's tax basis is? Just as important: Can you prove it?
Three Elements of BasisYour home's tax basis has three elements which you must combine to determine its adjusted basis when you sell or otherwise dispose of it.
Original Cost of Property
If you’ve purchased your home, your starting point for determining the property’s basis is what you paid for it. This includes the purchase price, plus closing costs, such as settlement fees, appraisal fees, legal fees, transfer taxes, title insurance premiums, credit report fees, inspection costs, and amounts owed by the seller that you agree to pay.
The cost of any improvements you make to your home while you own it are added to its basis. This reduces the amount of gain you'll realize when you sell the property. 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, and new roofs.
In addition, assessments for items that tend to increase the value of your property, such as streets and sidewalks, should be added to its basis.
Other Basis Adjustments
Certain other items must be subtracted from your basis, which increases any profit you realize when you sell the home. These include:
- insurance reimbursements for casualty losses
- deductible casualty losses that aren't covered by insurance
- deferred gain(s) on home sales before 1998, and
- depreciation claimed after May 6, 1997 if you used your home for business or rental purposes.
Proving Your Tax Basis to the IRS
You need to document each element of your home's tax basis. The original cost can be documented with copies of your purchase contract and closing statement.
Improvements should be documented with purchase orders, receipts, cancelled checks, and any other documentation you receive. The records homeowners most often lose are those for improvements, so you should take special care to keep track of these. It's a good idea to list them all in your records with a running total.
You should keep all improvement-related records for as long as you own the home, plus at least three years after you file your tax returns for the year of the sale. But if you sold a home before May 7, 1997, and postponed tax on any gain, the basis of that home affects the basis of the new home you bought. This means you need keep records proving the basis of the prior home or homes for as long as you postpone your gains.
Also, you should keep copies of all your tax returns forever.
Especially if you plan to live in your home for many years, you should take care that your basis records are not lost, destroyed, or misplaced. You may wish to keep them in a safe deposit box with your other valuable records. Another alternative is to make digital copies of the records and store them online.
More Information on Tax Basis
For more on the subject of figuring gain or loss and determining basis, see IRS Publication 523, Selling Your Home.