Tax Basis

Definition

Tax Basis, often referred to simply as Basis (Tax), is the amount of a taxpayer’s investment in property for tax purposes. Generally, the Tax Basis of a property is its purchase price, sometimes adjusted for improvements, depreciation, and other factors. It serves as the starting point for calculating capital gains or losses when the property is sold. The Adjusted Tax Basis reflects subsequent changes to the property’s value, which can increase (due to further investments) or decrease (due to depreciation).

Examples

Home Purchase: If an individual purchases a home for $300,000, the initial tax basis is $300,000. If they later add $50,000 worth of improvements, the Tax Basis increases to $350,000.
Depreciable Asset: A business buys a commercial building for $500,000. Over ten years, it claims $100,000 in depreciation. The Adjusted Tax Basis of the property is $400,000.

Frequently Asked Questions (FAQs)

How is the tax basis of a property determined?

The Tax Basis is typically its purchase price, including certain costs associated with the acquisition, like closing fees. It can also be adjusted for improvements, damages, and depreciation.

What is Adjusted Tax Basis?

Adjusted Tax Basis is the initial Tax Basis after accounting for adjustments such as capital improvements and depreciation.

How does depreciation affect tax basis?

Depreciation reduces the property’s tax basis. Each year, as depreciation is claimed, the tax basis is adjusted downward by the amount of depreciation claimed.

Can you have a negative Adjusted Tax Basis?

No, the Adjusted Tax Basis cannot go below zero. Once it reaches zero, no further depreciation deductions can be taken.

Why is a property’s Tax Basis important?

The Tax Basis is crucial because it determines the capital gain or loss when the property is sold. The gain or loss is the difference between the sale price and the Adjusted Tax Basis.

Adjusted Tax Basis: The original tax basis of property adjusted for improvements, depreciation, and other factors.
Capital Gains: The profit realized when a property is sold for more than its adjusted tax basis.
Depreciation: The reduction in the value of an asset over time, which can affect its tax basis.
Fair Market Value (FMV): The price at which property would sell for on the open market.
Cost Basis: Another term for tax basis; the original value of an asset for tax purposes.
Amortization: The gradual reduction of an asset’s value over time, similar to depreciation.
Acquisition Cost: The total cost associated with acquiring a property, including the purchase price and other related expenses.

Online Resources

References

“Federal Income Taxation of Individuals” by Daniel Lathrope.
“Real Estate Investment: Strategies, Analysis and Management” by David M. Geltner & Norman G. Miller.
IRS Publication 551 - Basis of Assets.
IRS Publication 946 - How to Depreciate Property.

Suggested Books for Further Studies

“Principles of Real Estate Practice” by Stephen Mettling and David Cusic.
“Real Estate Accounting and Taxation” by Timothy S. Mahoney.

Real Estate Basics: Tax Basis Fundamentals Quiz

### What is the initial tax basis of a property usually based on? - [x] The purchase price of the property - [ ] The property's closing costs - [ ] The property's assessed value - [ ] Future market value > **Explanation:** The initial tax basis of a property is usually based on the purchase price of the property. ### How does depreciation affect the tax basis of a property? - [ ] It increases the tax basis. - [ ] It has no effect. - [x] It decreases the tax basis. - [ ] It can either increase or decrease it. > **Explanation:** Depreciation decreases the tax basis of the property over time. ### What occurs to the tax basis when improvements are made to the property? - [ ] It remains unchanged. - [x] It increases. - [ ] It decreases. - [ ] It can either increase or decrease. > **Explanation:** When improvements are made to the property, the tax basis increases by the cost of the improvements. ### Can Adjusted Tax Basis be less than zero? - [ ] Yes, in special cases. - [ ] Sometimes, depending on factors. - [x] No - [ ] Yes, it normally is. > **Explanation:** Adjusted Tax Basis cannot be less than zero. ### How do you calculate capital gain on a property? - [ ] By subtracting the market value from the sale price. - [ ] By adding the sale price and original purchase price. - [x] By subtracting the Adjusted Tax Basis from the sale price. - [ ] By subtracting depreciation from the purchase price. > **Explanation:** Capital gain is calculated by subtracting the Adjusted Tax Basis from the sale price of the property. ### Which term describes the original value of an asset for tax purposes? - [x] Tax Basis - [ ] Market Value - [ ] Sale Price - [ ] Book Value > **Explanation:** The term "Tax Basis" describes the initial value of an asset for tax purposes. ### Does Adjusted Tax Basis account for damages to a property? - [ ] No, it only accounts for improvements and depreciation. - [x] Yes, it accounts for any factor affecting property value, including damages. - [ ] No, damages are considered separately. - [ ] Only if reported to the IRS. > **Explanation:** Adjusted Tax Basis accounts for improvements, depreciation, and damages among other adjustments. ### What is another name for Tax Basis? - [ ] Fair Market Value - [ ] Depreciated Value - [x] Cost Basis - [ ] Adjusted Cost > **Explanation:** Another name for Tax Basis is Cost Basis. ### Who sets the rules for determining tax basis? - [ ] Local municipalities - [ ] State governments - [ ] Real estate agents - [x] The Internal Revenue Service (IRS) > **Explanation:** The Internal Revenue Service (IRS) sets the rules for determining tax basis. ### When can the tax basis of a property be adjusted? - [ ] Only on improvements. - [ ] Only on depreciation. - [ ] Only at sale. - [x] At various points due to improvements, depreciation, and other factors. > **Explanation:** The tax basis of a property can be adjusted at various points due to improvements, depreciation, damages, and other factors.