What Types Of Costs Can Be Included In The Cost Basis?

Understanding which expenses, fees, and charges can fall into the cost basis column can be helpful, especially when it comes time to sell or exchange real estate holdings.

Capital Gains

Learn about the meaning and definition of a capital gain and how to calculate capital gains.

A Review of Cost Basis

Cost basis, when used in the context of investment real estate, is what you originally paid for that asset. Also known as “tax basis” or simply “basis,” the cost basis also includes additional fees and expenses related to the property’s acquisition. So when you buy a property that is used for investment or trade, that basis will consist of what you paid, and the following.

Unpaid Real Estate Taxes

If the seller owed real estate taxes on the property you bought, and you paid them without reimbursement, this can be treated as part of your basis. Keep in mind that you can’t deduct this as a tax.

Settlement Fees/Closing Costs

You can add various expenses connected to buying your property to your basis (with the exception of fees and costs for obtaining a mortgage or property loan). Some of these expenses include:

  • Abstract of title fees
  • Utility installation service charges
  • Legal fees
  • Recording fees
  • Surveys
  • Transfer taxes
  • Owner title insurance
  • Seller-owed costs you agree to pay, including back taxes or interest, recording or mortgage fees, improvement or repair charges, and sales commissions.
  • Mortgage assumption (includes what you pay for the property and the extra amount owed on the mortgage)

Construction Expenses

If you’re building on your property, the following can be added to your basis:

  • Land
  • Labor and materials
  • Architect and contractor fees
  • Building permit changes
  • Rental equipment charges
  • Inspection fees

Going one step further, perhaps you own your own business, and are developing a new office building to house your staff. If you’re paying for that development, the following should be included in the basis:

  • Employee wages paid for the construction work (reduced by allowed employment credits)
  • Depreciation on owned equipment used in construction
  • Operating and maintenance costs on equipment used in construction
  • Cost of business supplies and materials used in construction

The general rule of thumb concerning what to add to your basis is the price you paid for that investment, plus expenses directly related to the acquisition and/or development of that asset.

Why Higher is Better

There are two reasons why a higher basis on your real estate investment is more advantageous for you.

Lower Taxes on Gains from a Sale

Capital gain is the difference between what you sell your capital asset for and the asset’s basis. Put simply, it’s the amount of profit generated by subtracting the initial basis from the sales price. The need-to-know here is that the gain is taxed. But increasing your basis can bring it closer to the selling price, which could decrease the resulting gain, and potential taxes owed. 

Higher Annual Depreciation Reductions

Maximizing your initial cost basis means you can also increase depreciation during your hold of the property. Through this, you can deduct a certain portion of your basis each year which, in turn, can reduce taxable income. The higher the expenses added to your basis, the higher the annual depreciation deductions you might be able to take. Do keep in mind, however, that when you sell that asset, you could be on the hook for depreciation recapture expenses.

Overall, the initial cost basis is important because it’s technically a starting point when it comes to selling or exchanging real estate assets. It also can tell you what you might owe in capital gains taxes.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. 

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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