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Computing your home's basis

Trying to anticipate what you'll owe the Internal Revenue Service when you sell your home? Although tax rules allow sellers to avoid taxes on $250,000 ($500,000 if they're married and file joint returns) of home-sale profit, you must know how to compute your personal residence's basis before you can calculate any gain or loss.

The basis in your home originates when you acquire it. Calculation of the original basis depends on the way you acquire your home.

There are four common ways to acquire your home:

  • Buy or build it.
  • Receive it as a gift.
  • Inherit it.
  • Receive it from ex-spouse as a result of divorce.

If you buy or build your home, the amount you pay for it determines your basis. This includes most settlement or closing costs you paid when you bought it and any debt you assumed. If you built your home, your basis includes the settlement or closing costs of both acquiring your lot and securing your mortgage.

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If your home was a gift, your basis will be the same as the donor's adjusted basis at the time it was given to you. However, if you realize a loss on the sale of your home, your basis is the lesser of the donor's adjusted basis or the fair market value on the date it was given to you.

If you inherited your home, your basis is the fair market value on the date of the deceased's death. This value is recorded on the federal estate and/or the state inheritance tax return filed for the deceased. If you receive your home from your ex-spouse after your divorce, your basis is the same as the ex-spouse's just before the transfer took place.

After you acquire your home, various events can increase or decrease your original basis in your home. The effects of these events result in your adjusted basis.

Improvements increase home basis
Home improvements are the most common increase that occurs to a home's basis. There are limits on what the IRS considers an improvement. An improvement must accomplish one of the following three goals:

  • Materially add to the value of your home,
  • Considerably prolong its useful life, or
  • Adapt it to new uses.

Only the actual costs incurred for improvements can be added to your home's basis. You can't add a value for your own labor.

The following table contains some common examples of improvements:

Home improvements that increase your home's basis

Examples

Additions Extra bedroom, bathroom, deck, porch, garage, patio, fireplace Landscaping, driveway, walkway, fences, pool
Lawn and grounds
Communications Satellite dish, intercom system, security system
Heating and air conditioning
Electrical Lighting fixtures, wiring upgrades
Plumbing Water heater
Insulation Attic, walls, floors, pipes
Interior improvements Built-in appliances, kitchen or bath modernization, flooring, wall-to-wall carpeting
Miscellaneous Storm windows and doors, roof

There are two other important details about improvements to remember when calculating your home's basis. First, any improvement must remain with with the home when it is sold. The same expense can't be claimed twice. For example, if you replace a water heater more than once, you may only add the cost of the latest expenditure to basis.

Second, you have to distinguish between an improvement and a repair. A repair merely keeps your home in an ordinary and efficient operating condition. It doesn't add to the value of your home, prolong its life or adapt it to a new use. Bottom line? You can't add the repair cost to your home's basis.

Careful timing can transform a repair into a home improvement. Repairs completed as part of an extensive remodeling or restoration of your home are considered improvements, which means they can be added to your basis.

Also, the distinction between an improvement and a repair isn't always clear. For example, painting either a room or your entire house for the first time is an improvement, meaning the cost can be added to basis. A later repainting of the room or entire house is a repair, and this cost doesn't increase your basis.

Other adjustments to basis
Items aside from improvements can increase or decrease your home's basis. Common expenditures that will increase your basis include expenditures for restoring damaged property and assessing local improvements. Some common decreases to your home's basis are:

  • Insurance reimbursements for casualty losses.
  • Deductible casualty losses that aren't covered by insurance.
  • Payments received for easement or right-of-way granted.
  • Depreciation claimed if you used your home for business or rental purposes.
  • Deferred gain on a sale of previous residence(s).

Keeping records
In order to minimize your gain when you do sell your home, you'll need to go to some trouble today to set up a recordkeeping system to track any factors affecting your home's basis.

If you bought the home, keep the settlement statement. You'll need objective evidence as well if you have acquired your home by gift, inheritance or divorce. Make sure you hang on to receipts, canceled checks and other records for all basis adjustments, especially improvements.

Plan on keeping these records for as long as you own the home. After you sell the house, keep the records for three years after you file your tax returns for the year of the sale. The period of limitations, which is the period in which action can be taken against that particular year's return, expires after that time.

-- Updated: Feb. 5, 2003

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