Cost basis

What it means

Cost basis is what a property cost you in the eyes of the IRS. Not what you paid at closing, not what it is worth today — a specific figure, built from the purchase price and adjusted over time, that two calculations depend on.

It starts as the purchase price plus the buying costs you are required to capitalize: title insurance, recording fees, transfer taxes, legal fees, survey costs. It grows every time you make a capital improvement. And it shrinks every year by the depreciation you take.

The result of those adjustments is your adjusted cost basis, and it does two jobs:

1. It sets your annual depreciation deduction, once you strip out the land portion.
2. It sets your taxable gain when you sell — sale price minus selling costs minus adjusted basis.

Note that some closing costs are capitalized into basis and others, notably prepaid interest and prorated property taxes, are deducted as expenses instead. The settlement statement is the document that sorts this out, which is why it is worth keeping permanently.

Why it matters

Basis is quiet for years and then decides a very large number.

On the depreciation side, an error in basis repeats annually. Overstate it by $20,000 and you over-deduct roughly $727 every year for 27.5 years. Understate it and you under-deduct by the same amount, permanently, because the years you missed do not come back easily.

On the sale side, the arithmetic is blunt. A property bought for $310,000 and sold for $420,000 looks like a $110,000 gain. It usually is not. Add capitalized closing costs and improvements and your original basis is $334,600 — but subtract four years of depreciation at $9,331 and the adjusted basis drops to $291,036. The taxable gain is $128,964, not $110,000, and part of it is depreciation recapture taxed at a different rate than the rest.

That surprise is the reason basis deserves attention long before you are selling. The $18,200 of improvements only reduces your gain if you can show it — with invoices, dates and amounts, for work done possibly a decade earlier. Landlords who did not track improvements as they happened routinely pay tax on gain they did not actually make, simply because the paperwork is gone.

How it works in practice

Basis is a running figure. Build it and keep it.

	Amount
Purchase price	310,000.00
+ Capitalized closing costs (title, recording, legal)	6,400.00
+ Capital improvements — new roof, full rewire	18,200.00
Original basis	334,600.00
− Depreciation taken to date (4 years)	(43,563.64)
Adjusted cost basis	291,036.36

From that same figure, the depreciation calculation splits out land. If the county assessment puts land at $78,000, the depreciable basis is $256,600 and the annual deduction is $9,330.91 — which is the number feeding the depreciation line back into this table each year.

The two things that change basis after purchase are worth stating plainly:

Improvements go up. Anything that betters the property, restores it, or adapts it to a new use is added. A new roof, an added bathroom, a rewire, a replaced HVAC system.

Depreciation comes down. Every year, automatically, whether or not you claimed it.

Ordinary repairs do not touch basis at all — they are deducted in the year you pay them and disappear from this calculation entirely. That distinction is exactly why the repair-versus- improvement call matters beyond the current tax year.

Common mistakes

• Treating the purchase price as the basis. It is the starting point, not the answer. Capitalized closing costs and every improvement since belong in the figure.
• Losing improvement records. The most expensive mistake here, and the most common. Work done eight years ago still reduces your gain — but only if you can produce the invoice. Undocumented improvements are, practically speaking, worth nothing at sale.
• Forgetting to subtract depreciation. Basis goes down every year. A seller who computes gain against original basis will understate it substantially and be surprised at filing.
• Capitalizing the wrong closing costs. Prepaid interest and prorated property taxes are generally deducted, not capitalized. Title, recording and legal fees generally are capitalized. The settlement statement is the source document.
• Ignoring the land split. Land is part of basis for gain purposes but excluded from the depreciable portion. Conflating the two breaks both calculations.
• Not tracking basis per property. With multiple rentals, a single blended figure is unusable — Schedule E is per property and so is every calculation that flows from basis.

How BareBones PM helps

Basis is a long-horizon number, and long-horizon numbers are exactly what a shoebox loses.

BareBones PM stores the basis inputs on the property record: purchase price, capitalized closing costs, and the land/building split with the source you used. That figure does not need reconstructing each year, and the reasoning stays attached to it.

Capital improvements are recorded as depreciable assets against the property, each with its date, amount, and the invoice attached to the entry. Ten years later, the roof that went on in year four is still there with its documentation — which is the difference between reducing your taxable gain and paying tax on money you spent.

Depreciation accumulates against the property automatically, so adjusted basis stays current rather than being a calculation you perform under pressure when a sale is already in motion. When you do sell, the figure and its entire history are available together.

For how basis feeds the depreciation schedule, see Depreciation for landlords.