Property cost basis is a very important number because it refers to the investment cost of the property used for calculating gains or losses on the sale, exchange, or other disposition of property for tax liability purposes.
The basis of a property is usually its cost, that is, the amount paid in cash, debt obligations, other property, or services, or in other words its purchase price. If the property purchase involves assumption of an existing mortgage on the property, the basis includes the amount paid for the property plus the remaining balance on the mortgage.
According to the IRS, the following are some of the settlement fees or closing costs that can be included in the calculation of the cost basis of a property, if applicable.
• Recording fees
• Survey fees
• Abstract fees (abstract of title fees)
• Charges for installing utility services
• Legal fees (including fees for the title search and preparation of the sales contract and deed)
• Transfer taxes
• Owner’s title insurance
• Any amounts owed by the seller and paid by the buyer without being reimbursed by the seller, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions
A number of other items though can not be considered as settlement costs that can be added to the cost basis of the property. For example, amounts placed in escrow for the future payment of obligations, such as taxes and insurance are not included. Premiums for casualty insurance, rent and charges for utilities and other services related to occupancy of the property before closing, costs related to obtaining a mortgage loan (such as points, mortgage insurance, loan assumption fees, credit report charge, and valuation fees), and fees for refinancing a mortgage cannot be taken into account in the calculation of the cost basis of the property.
For purposes of calculating the capital gain from the sale of the property and the resulting tax liability the IRS requires further adjustment of the cost basis of the property to derive the adjusted basis, which will be eventually deducted from the net sales proceeds. These adjustments include the addition of capital improvement expenditures and the deduction of accumulated depreciation and any partial sales. Therefore:
Adjusted Basis = Cost Basis+Capital Impr. – Acc. Depr –Patial Sales