"Basis" is an important tax word that every homeowner should know. It's essential meaning is simple: It's the monetary value of a property for tax purposes. The reason it's important it that, when you eventually calculate whether you've realized a gain (and thus possibly owe tax) or incurred a loss upon selling your property, you'll need to start by subtracting its basis from the sales price. In other words, the greater your basis, the less capital gains tax you'll potentially have to pay when after selling your home. For example, if your home has a $500,000 basis and you sell it for $750,000, you have realized a $250,000 gain.
So, do you know what your home's tax basis is? Just as important: Can you prove it to the Internal Revenue Service (IRS)? That's what we'll discuss here.
If you've purchased your home, your starting point for determining it's basis is what you paid for it. This includes the purchase price, as well as closing costs such as settlement fees, appraisal fees, legal fees, transfer taxes, title insurance premiums, credit report fees, property inspection costs, and any amounts owed by the seller that you agreed 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 are more than everyday home repairs, such as painting or replacing a cracked window or a few roof tiles. They include any work done that adds to the value of your home, increases its useful life, or adapts it to new uses. These might include, for example, room additions, new bathrooms, decks, fencing, landscaping, wiring upgrades, new walkways or driveways, kitchen upgrades, plumbing upgrades, and a new roof. Restoring damaged property with something new or like-new also counts.
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.
Certain other items must be subtracted from your basis, which increases any profit you realize when you sell the home. These include:
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 take special care to keep track of these. It's a good idea to list them all in your personal 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. Also, you should keep copies of all your tax returns forever.
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 to keep records proving the basis of the prior home or homes for as long as you postpone your gains.
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 might 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.
Whether you actually owe tax upon selling your home depends in part on the amount of the gain. If, for example, 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 in a home is $400,00 and you sell it for $750,000, you'll realize a $350,000 gain on such a sale. Even with the $250,000 exclusion, $100,000 of your gain would still be taxable.
For more on the subject of figuring gain or loss and determining basis, see IRS Publication 523, Selling Your Home.