Cost Basis Of Rental Property

Owning a rental property can be an extremely rewarding experience until the tax season comes. When the first of the year rolls around, there are several factors that come into play that must be filed correctly so that your income and expenses are correctly reported. One of the common mistakes that happen during this time is the calculation of cost basis for the rental property you may have. How do you determine this cost basis?

It's a Rather Simple Calculation With a Lot of Numbers

To determine your cost basis for any rental property, you'll need to start with the purchase price of it. This is how much it cost you to obtain the property and is your starting point, even if you obtained a mortgage to get the rental property.

Any purchasing costs that were associated with the rental property when you initially obtained it are part of the formula as well. This includes any commissions to a real estate agent, any closing fees you might have paid, escrow fees, or even payments to existing tenants to have them move out of the rental unit. This also works in reverse. Any selling fees that are associated with the rental property are also part of the equation.

Improvements to the rental property that you have made within the last tax year can also be included in the cost basis formula. This might include the new roof that you had installed to make the property livable, land improvements, a new water heater because the old one rusted out and leaked all over the place, or new flooring. As long as it was an improvement that you paid for and it wasn't a repair, this can be included in the calculation.

Now You're Ready to Begin Subtracting Items

Depreciation is also part of the cost basis formula. It cannot be excluded and it begins from the first day you own something. It also accumulates, which means you'll have claims to the improvements, purchasing costs, and fees every year that you own the rental property.

Some depreciation costs are pretty simple. The overall cost of the rental property, for example, will depreciate at 27.5 years, so you just divide the cost of the property with the number of a year that it depreciates and that’s how much you'll deduct from the cost basis formula. Long-term improvements, such as a new roof, may also depreciate on this long term schedule.

Other items, such as a flooring improvement, may not depreciate on the same schedule. New carpet, for example, may take only 7 years to depreciate. If you've put new paint into a home, then it may only be 3 years until that improvement depreciates. Take all of the items that are depreciating and add their costs together for that year to get your accumulated depreciation. This number is then subtracted from all of your expenses and you'll have your cost basis figure.

When you know your cost basis, you'll be able to determine your actual gain or loss on a property. By taking the selling price and subtracting the cost basis, you'll receive your final figure for the year and let the taxing authority know how much you might owe them.
Posted on Oct 06, 2014


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