By Jodi Summers Days on the Market
YOU CAN SAVE ON TAXES WHEN YOU sell property if you understand the terms and how to apply them. Experts say the starting point for avoiding long-term capital gains tax on the profitable sale of your personal residence and investment real estate is its adjusted cost basis.
According to bankrate.com, the adjusted cost basis can be defined as, “The amount paid for an item, plus the amount paid for improvements, minus losses and depreciation. When the owner sells the item, the difference between the sales price and the adjusted cost basis is the profit or loss.”
Revered real estate columnist Robert J. Bruss offers this adjusted cost basis rule, “The starting point is usually the property purchase price, plus any purchase expenses that were not tax deductible at the time of purchase.”
Next, calculate in the cost of capital improvements made to the property. Capital improvements add value to your home, extend its life, or expand its use. New plumbing, a remodled master bath or a swimming pool qualifty. Add those expenses to your original cost to increase your adjusted basis, which in turn decreases the amount of gain on a sale.
Here’s a twist to the rule: If you had a new roof installed on your house valued at $10,000, add that number to your home’s adjusted cost basis. But, if you repaired a leaking roof at a cost of $1,000, that’s your expense and cannot be included as capital improvements. Furthermore, repair bills on a personal residence are not considered tax deductible. However, repair costs on an investment property are tax-deductible expenses in the tax year paid.
Now, subtract any depreciation, casualty losses, or energy credits that you have claimed to reduce your tax bill while you’ve owned the property. Also, if you postponed paying taxes on the gains made from selling a previous residence — as was allowed for homeowners prior to 1997 — then subtract that gain from your adjusted basis.
Add the total depreciation deducted on your tax returns and then subtract the total depreciation from the property’s adjusted cost basis.
Next, find the adjusted sale price by taking the gross sales price and subtracting non-deductible selling expenses such as the real estate sales commission, transfer taxes, and attorney or escrow fees. Your long-term capital gain is the difference between the adjusted sales price and the adjusted cost basis.
Turbotax.com explains and calculates the adjusted cost basis as follows: The Adjusted Basis is simply the cost of your home adjusted for tax purposes by improvements you’ve made or deductions you’ve taken.
For example, if the original cost of the home was $100,000 and you added a $5,000 patio, your adjusted basis becomes $105,000. If you then took an $8,000 casualty loss deduction, your adjusted basis becomes $97,000.
Here’s how to calculate the adjusted basis on a home: 1. START WITH: ■The purchase price of your home (as described above), or ■If you filed Form 2119 when you originally acquired your old home to postpone gain on the sale of a previous home (back in 1997 or earlier), use the adjusted basis of the new home calculated on your Form 2119. 2. TO THAT STARTING BASIS, ADD: ■The cost of any improvements that added value to your home, prolonged its useful life, or gave it a new or different use. ■Any special tax assessments you paid. ■Amounts spent after a casualty (disaster such as a hurricane or tornado) to restore damaged property. 3. FROM THAT UPWARDLY ADJUSTED BASIS, SUBTRACT: ■ Certain settlement fees or closing costs. ■Depreciation allowed for any business use portion of your home. ■Residential energy credits claimed for capital improvements. ■Payments received for easements or right-of-ways. ■Insurance reimbursements for casualty losses. ■ Casualty losses (from accidents and natural disasters) that you deducted on your tax return. ■Adoption credits or nontaxable adoption assistance payments for improvements added to the basis of your home. ■First-time homebuyers credit. ■Energy conservation subsidies excluded from your gross income.
The result of all this calculating is the adjusted basis that you will subtract from the selling price to determine your gain or loss. This adjusted basis is what’s considered to be your cost of the home for tax purposes.
For more information please go to http://turbotax.intuit.com/tax-help/selling-a-home.
JODI SUMMERS negotiates investment properties for Sotheby’s International Realty. She or (310) 260-8269. Visit her Web sites at www.SoCalInvestmentRealEstate.com and www.santamonicalandmarks.com.
Originally published in the Santa Monica Daily Press print edition on March 7, 2007. Read the original PDF.