How to Determine Tax Basis of Real Estate and Capital Assets

A home holds incalculable value to a family. It’s a place to grow together and make countless memories. It can also be significantly valuable if you rent your home out in the future, or you own rental real estate. Capital assets of your business also hold tremendous value. Unfortunately, the IRS will require you to have a clear understanding of the value of these assets and other properties you own.

Above all else, a property’s tax basis will dictate many of the long-term tax implications that derive from it. The tax basis of real estate assets and most other capital assets will fluctuate over time based on the work you do to it, the age of the asset, and the condition of the asset.

Appreciation and Depreciation Impact Tax Basis

Unlike other assets, property and most capital assets will not have the same tax basis throughout the life of the asset. If you purchase a rental property for $500,000 and do no additional work and sell it for $600,000 then your tax basis remains at $500,000. If you purchase a rental property for $500,000 and then put an additional $50,000 of work into it then the tax basis would rise to $550,000. Even if you have a mortgage on a $500,000 property, the total value of $500,000 still determines the tax basis of the home even if you have not yet paid off the mortgage.

The opposite applies, as well. If you purchase a $500,000 rental property and claim depreciation of $100,000 over ten years then the tax basis will lower to $400,000 at the end of that period. If the home is sold before this period then you would just calculate your tax basis based on the portion of that ten-year period that has passed. If it’s been three years then the property would have a tax basis of $470,000 ($10,000 of depreciation a year for three years).

Tax Basis Determined Capital Gains

All of this becomes relevant when you or your business moves to sell a qualified asset. The IRS is going to tax you on the difference between the asset’s tax basis and the sale price. In the example of the $500,000 rental property, we can have several different outcomes depending on what happens to the home between the time of purchase and time of sale:

  • You put $100,000 of additional work in the property and then sell at $650,000, creating a surplus (aka capital gain) of $50,000 that is taxable ($500,000 original basis plus $100,000 of additional work equals a new tax basis of $600,000)
  • You claim a $100,000 depreciation over ten years but then sell the property for $600,000, creating a surplus of $200,000 that is taxable ($500,000 original basis minus $100,000 depreciation deduction claimed equals a new tax tasis of $400,000)
  • You put $100,000 of additional work in but claim $150,000 in depreciation and then sell for $500,000, creating a $50,000 surplus that is taxable ($500,000 original basis plus $100,000 of additional work equals $600,000 of new bais, adjusted downward for the depreciation deduction claimed of $50,000)

The work you put into the asset and the depreciation you claim will be the two biggest factors in determining an asset’s tax basis over time. It’s imperative that you keep track of all this and have an understanding of your assets’ adjusted basis over time.

You also don’t have to do all this math yourself. You can work with tax professionals and firms who understand how all this is calculated to keep your money and your business moving forward. Contact The Law Offices of Tyler Q. Dahl to make sure your business’ growth isn’t slowed by costly tax mistakes.

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Dahl Law Group

At Dahl Law Group, we’re not just a law firm. We’re your trusted advisor for your business and family from beginning to end. As your family and business grow, we will be there by your side. Our passion is providing you with peace of mind and protection through personalized estate and business planning.

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