When you and sell your home at a profit, you could end up owing federal capital gains taxes. Taxes have to be paid on your net profit, which is the amount by which the purchase price exceeded what's called your "adjusted basis" in the property. The larger your adjusted basis, the less taxable profit you'll have.
Unfortunately, many people who own a condo, townhouse, or other property in a homeowners' association end up overpaying capital gains tax, because they don't property calculate their adjusted basis. We'll discuss how to correctly determine it here, including how to factor in capital improvements made by your homeowners' association.
For tax purposes, "basis" means your total monetary investment in property. You begin with your starting basis, which usually consists of the property's cost plus related buying expenses. This figure is adjusted on an ongoing basis to reflect various additions and reductions. The total amount is your adjusted basis.
Each year, you subtract from your basis the amount of any depreciation deductions you took on the property, for example if you had a home office or business there, or rented it out. You add to your basis the cost of any improvements you made to the property, such as a new furnace or bathroom sink. (Regular repairs don't count, however.)
Since you want your adjusted basis to be as large as possible, the more improvements you add while you own the property, the better. In the case of condominiums, however, what constitutes an improvement for each owner can be confusing.
When you own a condo, there are two types of improvements whose cost should be added to your adjusted basis.
The first type are improvements you make to your specific unit; for example, you remodel your kitchen or bathroom.
The second type of improvements you can add to your adjusted basis are capital improvements that your homeowners' association makes to the building's common areas. These could include, for example, replacing a roof, an elevator, or a central heating and air conditioning system. But you don't get to add the entire cost of say, the shared roof or elevator. Your pro rata share of the cost of these improvements should be added to your adjusted basis. Your homeowners' association should be able to tell you how much this is.
Example: Jean owns a home in a 100-unit condominium in Florida that she has rented out for the last ten years. She paid $100,000 for the unit, so that is her starting basis. During the time that Jean owned the unit, she spent $20,000 to remodel the kitchen and bathroom, and replaced the carpets. During the years she rented the condo, she also took $4,000 in depreciation deductions. In the meantime, Jean's homeowners' association spent $3 million to upgrade the property, including installing a swimming pool and replacing the roof. Jean owns a 1% interest in the condominium common areas, so her pro rata share of these improvements is .01 x $3,000,000 = $30,000. Jean adds this to the $20,000 of improvements she made to her own condo, resulting in $50,000 of improvements that she adds to her starting basis. She subtracts the $4,000 in depreciation deductions. Jean's adjusted basis is $146,000. She sells the condo for $200,000. Thus, Jean's taxable profit is $54,000. Had Jean not counted her $30,000 share of improvements made by her homeowners' association, her taxable profit would have been $84,000.
Note that if you own a stock-cooperative instead of a condominium, you may also add to your adjusted basis your share of the costs to pay down the principal on the building's mortgage. This does not apply to condo owners, because there is no mortgage on the building itself.
For more information on capital gains tax, see Avoiding Capital Gains Tax When Selling Your Home: Read the Fine Print.