The tax basis of a home is its value for tax purposes. Calculating the profit or loss from selling a home requires determining its tax basis on the date of the sale and subtracting that basis from the price of the sale, while accounting for costs related to the sale. As this formula suggests, selling a home with a greater tax basis will result in a smaller taxable profit. A homeowner will incur a loss if the tax basis for their home is greater than the price of the sale. (You cannot deduct this type of loss.) The tax basis of a home may be adjusted over time, either upward or downward.
Calculating the Starting Tax Basis
In most cases, the starting tax basis for a home is the cost basis, which is the purchase price that the homeowner paid for the home. The cost basis may include an amount that is owed on a pre-existing mortgage taken out by the previous owner of the home, since the current owner takes over the responsibility for paying this amount. It also will include real estate taxes, title insurance, and other fees related to the purchase of the home, which usually will be found in the closing statement.
However, sometimes a homeowner builds a home or receives it as a gift, so the cost basis will not apply. If you built your own home, the starting basis will consist of the construction costs, including amounts paid for materials, equipment, and labor, as well as interest on loans during construction. If you received your home as a gift, you generally will use the tax basis of the home at the time that the gift was made. If you inherited a home, the starting basis will be the fair market value at the time of the owner’s death.
Certain steps will increase the tax basis of a home. These include improvements or additions to the home, except for improvements that were later removed or replaced. An improvement consists of any project that adds to the value of the home, adds a new use to the home, or makes it more durable over time. The tax basis also will increase based on any tax credits received for home energy improvements after 2005. It will increase if you needed to restore your home after damage or loss caused by various natural disasters or crimes. If you incurred legal fees while you were protecting your rights to the property, these will increase the tax basis. Costs for extending utility service lines to a home also can increase its tax basis. Finally, the tax basis may be increased if you paid assessments for improvements by the local government that increased the value of the property.
On the other hand, the tax basis of a home may be adjusted downward in some cases. If your home suffered damage or loss, payments from a related insurance policy would result in a downward adjustment. Deductible casualty losses that were not covered by an insurance policy also may result in a downward adjustment. The tax basis of your home may be reduced on the basis of depreciation if you use part of the home for business purposes or rent part of it to a tenant. If you received money from a neighbor or another party for providing them with an easement, this will result in a downward adjustment. Finally, if you sold a previous home before May 7, 1997, profits from that sale will reduce the tax basis of the current home.