The cost basis for capital gains and lossesPublished:
When an asset is sold, its cost basis is used instead of the actual purchase price to determine the accurate capital gain or loss for capital gains tax purposes. This is very important to remember because it can result in a tremendous difference in the amount of capital gains tax due when an asset is sold.
If the asset is real property, also known as real estate, it refers to land and typically anything built on, growing on, or attached to the land. Regarding real estate, the cost basis of an asset is the original purchase price plus the settlement and closing costs, including the fees and taxes you paid to acquire the property whether you paid for them in cash, in trade or through a loan. Fees include real estate brokerage fees or commissions, legal fees, recording fees, accounting fees, installation and testing fees, transfer and sales fees. Taxes include sales tax, excise tax, revenue stamps, real estate taxes, etc. Depreciation must be added to the original cost basis to accurately report capital gains tax.
Depreciation may be deducted only on the part of your property used for rental purposes as it reduces the yearly income tax paid by the investor by reducing the reportable net rental income. Depreciation increases the capital gains tax when the property is sold or exchanged for another property or asset.
When a property is purchased, make sure you retain a copy of all documents that can support the cost basis calculation. If you make any improvements to a property such as adding a garage or another type of major remodeling or addition, make sure you keep copies of any and all expenses related to the improvement since those items will also be added to your cost basis and affect your capital gain or loss calculation. On the other hand, if you take deductions on your taxes for depreciation of the property or for casualty losses, or you claim certain tax credits, you need to subtract those items from your original cost basis. The manner in which the real property is purchased can impact the cost basis and the amount of capital gains tax that will apply. For example, property purchased through a no/low interest loan or via a lump sum payment have different capital gains tax treatments for capital gain or loss calculations. As the rules for reporting capital gains tax on real estate can be confusing, you should consult a professional tax preparer for advice.