Adjusted Cost Basis: How to Calculate Additions, Deductions

The cost basis of an investment or asset is the amount of the initial investment, or the original purchase price. It's a critically important number in tax planning for individual investors, business owners, and heirs receiving inheritances.

The cost basis determines how much capital gains tax must be paid once an investment or other asset is sold. For certain assets, such as real estate or stocks that have been owned for many years, a very low basis can result in a heavy tax burden when they are sold.

However, the IRS allows for assets and investments to be adjusted up or down for a number of reasons, resulting in the adjusted cost basis and less capital gains tax owed.

This calculation can be complicated depending on the type of asset and the extent to which additions or deductions are allowed.

Key Takeaways

  • The cost basis of a home or any other asset must be reported to the IRS when you sell it.
  • The cost basis is subtracted from the profit that will be taxed.
  • The basis may be lowered to reflect the costs of improvements you paid for and expenses you incurred while you owned the asset.

When the Asset Is a Gift

Figuring your cost basis when you sell property that you received as a gift is more complicated. You need to know: a) its adjusted basis to the owner just before it was given to you; b) its full market value at the time it was given to you, and c) the amount of gift tax, if any, that you paid.

Calculating Additions to Cost Basis

The cost basis of an asset or investment may be adjusted upwards by adding the initial cash basis used to purchase the asset to the costs associated with increasing the value of the asset.

For a business, these costs may include capital expenses such as substantial repair or rehabilitation expenses for equipment or facilities.

For a homeowner, a renovation or room addition can be added to the original cost basis, adjusting the amount up. Legal fees associated with the purchase or sale of the asset, title fees, transfer fees, and sales tax all may be used to adjust the cost basis up.

The owner of an asset may also use the costs associated with selling it to reach an adjusted cost basis. Common expenses related to the sale of some assets can include broker fees, seller commission, and costs for shipping the item to a buyer.

The addition of any of these expenses to the original purchase price of the asset results in a higher adjusted cost basis, reducing the amount of capital gains taxes owed at the time of sale.

Calculating Deductions to Cost Basis

Cost basis can be adjusted downward by subtracting any capitalized costs directly related to the asset. Common expenses that reduce an asset's cost basis include depreciation, damage to the asset, or theft. Depletion or amortization can also be used to adjust the cost basis of an asset downward.

Business owners have the option of receiving the tax benefit of these deductions at the time of purchase or at the time of sale.

An adjusted cost basis that includes deductions to the value of an asset can be particularly beneficial to investors or business owners when the sale results in a loss. These losses can be used to reduce taxable income up to a certain amount each year, and excess losses can be carried forward in future years.

What Can I Deduct From My Cost Basis When I Sell My Home?

Many of the costs associated with purchasing and upgrading your home can be deducted from the cost basis when you sell it. These include most fees and closing costs and most home improvements that enhance its value. It does not include routine repairs and maintenance costs.

What Can I Deduct From My Cost Basis When I Sell Stocks or Bonds?

The IRS defines the cost basis of the stock shares or the bonds as their purchase price plus any costs related to the transaction such as broker fees. When you sell shares of mutual funds, you can in some cases use an average cost basis.

What Are Increases to Cost Basis vs. Decreases to Cost Basis?

Increases to your cost basis include improvements such as a new roof on a house and the cost of local tax assessments for water connections or roads.

Examples of decreases to cost basis include insurance deductions, subsidies for energy enhancements, and depreciation.

The Bottom Line

Additions and subtractions to the cost basis of an asset can dramatically change the amount you owe in taxes when the asset is sold. That's the best argument for good recordkeeping. Hold onto receipts and other documents that detail improvements you have made to your home over time in order to accurately record its real cost to you.

Article Sources
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  1. Internal Revenue Service. "Publication 551 (12/2022), Basis of Assets."

  2. Internal Revenue Service. "Topic No. 409, Capital Gains and Losses."

  3. Internal Revenue Service. "Topic. No. 703: Basis of Assets."

  4. Internal Revenue Service. "Publication 523: Selling Your Home."

  5. Internal Revenue Service. "Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)," Pages 66-67.

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