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
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.
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.
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
The following table contains some common examples
Home improvements that increase your
bathroom, deck, porch, garage, patio, fireplace Landscaping,
driveway, walkway, fences, pool
dish, intercom system, security system
and air conditioning
fixtures, wiring upgrades
appliances, kitchen or bath modernization, flooring, wall-to-wall
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
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
- Payments received for easement or right-of-way
- Depreciation claimed if you used your home
for business or rental purposes.
- Deferred gain on a sale of previous residence(s).
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,
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