What Is Adjusted Basis of Property? Increases, Decreases, and Sales

The adjusted basis of property is what you have invested in it for tax purposes: your original cost basis, plus qualifying additions like capital improvements, minus reductions like depreciation and casualty losses. The IRS uses this figure to calculate your taxable gain or loss when you sell, so an accurate number can be the difference between a small tax bill and a large one. The formula itself is simple. The work is in tracking every adjustment over the years you own the property.

Where the Number Starts: Cost Basis

For property you buy, your starting basis is generally what you paid, including cash, any debt you took on, and the fair market value of anything you traded.¹ The purchase price is only part of it.

Certain closing costs get folded in from day one: abstract and title search fees, recording fees, surveys, transfer taxes, owner’s title insurance, and legal fees for preparing the deed and sales contract. If you agreed to pay costs the seller owed, such as back taxes or sales commissions, those count too.²

Costs tied to your mortgage rather than to the property itself do not get added. Loan origination fees, mortgage insurance premiums, and points used as prepaid interest stay out of basis.³ A useful test: if you would pay the fee even when buying with cash, it belongs in basis; if it exists only because you financed the deal, it doesn’t.

Starting Basis When You Didn’t Buy the Property

How you acquired the property changes the starting number entirely.

Inherited Property

Property you inherit generally receives a stepped-up basis equal to the fair market value on the date the prior owner died. If a parent bought a house for $80,000 in 1985 and it was worth $400,000 at death, your starting basis is $400,000. Decades of unrealized appreciation disappear at that moment.⁴

The estate executor can instead elect an alternate valuation date six months after death, which values all estate assets at that later date. The election is irrevocable and available only if it decreases both the gross estate value and the estate tax owed.⁵ One narrow exception: if you gave appreciated property to someone who died within one year and it passes back to you, no step-up applies. Your basis is the decedent’s adjusted basis right before death.⁴

Gifted Property

Receive property as a gift and you generally take over the donor’s adjusted basis. If your mother’s basis in a rental was $150,000, yours starts at $150,000 no matter the current market value.⁶

There is a trap. If the fair market value at the time of the gift was lower than the donor’s basis, a dual basis rule applies. You use the donor’s basis to figure any gain, but the lower fair market value to figure any loss. Sell between those two figures and you recognize neither gain nor loss.⁶ Ask the donor for their records at the time of the gift, not later.

Property from a Divorce

Transfers between spouses, or between former spouses when the transfer is incident to the divorce, produce no taxable gain or loss. The receiving spouse takes over the transferring spouse’s adjusted basis.⁷ A transfer counts as incident to the divorce if it happens within one year after the marriage ends or is otherwise related to the settlement.

The number matters in negotiations. A house worth $500,000 with a basis of $100,000 is not equivalent to $500,000 in cash. The house carries $400,000 of built-in taxable gain that the receiving spouse will eventually owe tax on. Know the adjusted basis of every asset on the table, not just its market value.

What Increases Basis

Capital improvements are the main way basis grows. An improvement must add value, extend useful life, or adapt the property to a new use: a new roof, an added bedroom, a paved driveway, central air conditioning.² Routine maintenance does not qualify. Patching drywall, painting, fixing a leaky faucet — these keep the property in its condition rather than improving it, so they stay out.

Other additions to basis:²

Legal fees paid to defend or perfect title to the property.
Local assessments for permanent improvements like road paving, sidewalks, or water and sewer line connections.
Costs to rezone the property for a different use.
The cost of extending utility service lines to the property.

You cannot add the value of your own labor. Build a deck yourself and only the materials count. The IRS excludes unpaid labor, whether yours or anyone else’s, from basis.²

What Decreases Basis

Downward adjustments matter just as much. Miss them and you understate the gain when you sell, which the IRS treats as an underpayment.

The rule that surprises people: your basis drops by depreciation you were allowed to take, whether you actually claimed it or not.⁸ Skipping a depreciation deduction on a rental doesn’t preserve the higher basis; it just costs you the deduction and still reduces your basis.

Common reductions include:

Depreciation on business or rental use, allowed or actually taken.
Section 179 expensing, when you deducted the full cost of business property in the year of purchase.
Casualty and theft losses you claimed, plus any insurance reimbursements you received.
Residential energy credits, such as credits for solar panels or heat pumps, which reduce the home’s basis by the credit amount.⁹
Payments received for granting a permanent easement, such as letting a utility run lines across your land.²

If a property serves both personal and business use, only the business-use portion is depreciated and only that portion’s basis is reduced.¹⁰

Why the Number Matters When You Sell

Your gain equals what you received minus your adjusted basis. A higher adjusted basis means less taxable gain. That single arithmetic fact is why the tracking is worth doing.

Hold the property more than one year and the gain is taxed at long-term capital gains rates of 0%, 15%, or 20% depending on your income. Hold it a year or less and the gain is taxed as ordinary income, which runs as high as 37%.¹¹

Two features of the sale calculation deserve special attention for real property.

The Home Sale Exclusion

If you sell your primary residence, you can exclude up to $250,000 of gain from income, or $500,000 for married couples filing jointly. To qualify, you must have owned and used the home as your main residence for at least two of the five years before the sale.¹² For joint filers, both spouses must meet the use requirement; only one needs to meet the ownership test. You still need your adjusted basis to know whether your gain stays under the exclusion at all.

Depreciation Recapture

Selling rental or business real estate triggers an added layer of tax. The portion of your gain attributable to depreciation you took, or were allowed to take, is taxed at a maximum rate of 25%.¹¹ Own a rental for 15 years, claim $80,000 in depreciation, and that $80,000 slice of your gain gets recaptured at up to 25% regardless of how the rest is taxed. Because the basis reduction happens whether or not you actually claimed the deductions, this is where missed depreciation hurts twice: no deduction earlier, full recapture later.

Like-Kind Exchanges

A Section 1031 like-kind exchange lets you defer gain on the sale of investment or business real property by rolling proceeds into replacement property. Your basis in the new property carries over from the old, reduced by any cash you received and increased by any gain you recognized.¹³ Since 2018, only real property qualifies. The tax is postponed, not erased, because the carried-over basis produces a larger eventual gain.

Records to Keep, and for How Long

Your settlement statement is the foundation. For purchases before October 2015, that is the HUD-1 Settlement Statement; for later purchases, the Closing Disclosure.¹⁴ Add to that every invoice and receipt for capital improvements, prior returns showing depreciation, insurance claim records, and documentation of any credit that reduced basis.

The retention rule for property records is stricter than the general three-year window. Keep the records until the statute of limitations runs on the return for the year you dispose of the property. In practice, that means keeping basis records for the entire time you own the property, plus at least three years after filing the return for the year of sale. Buy a rental in 2010 and sell in 2030, and you need the 2010 closing documents until at least 2034. If the property came to you through a tax-free exchange, keep the records from the original property too, since your basis traces back to it.¹⁵

Reporting Adjusted Basis on Your Return

Sales of property are reported on Form 8949, which feeds Schedule D on Form 1040. Your adjusted basis goes in the “Cost or Other Basis” column.¹⁶ If a broker reported a basis on Form 1099-B that doesn’t match your records, enter the broker’s number and use the adjustment column to correct it.¹⁷ Subtotals from Form 8949 flow to Schedule D, where long-term and short-term results are calculated separately. Most tax software handles the transfer automatically; paper filers attach both forms.

One boundary worth naming: the same adjusted-basis concept applies to stocks, mutual fund shares, and other securities, but the rules for tracking lots, reinvested dividends, and wash sale adjustments are their own topic. If you’re selling securities rather than property, the mechanics above won’t cover everything you need.

1
Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property-Cost
2
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
3
Internal Revenue Service. Rental Expenses
4
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets – Section: Inherited Property
5
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
6
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
7
Office of the Law Revision Counsel. 26 USC 1041 – Transfers of Property Between Spouses or Incident to Divorce
8
Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
9
Internal Revenue Service. Instructions for Form 5695 (2025)
10
Internal Revenue Service. Simplified Option for Home Office Deduction
11
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
12
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain from Sale of Principal Residence
13
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use in a Trade or Business or for Investment
14
Consumer Financial Protection Bureau. What Is a HUD-1 Settlement Statement?
15
Internal Revenue Service. How Long Should I Keep Records?
16
Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets
17
Internal Revenue Service. Instructions for Form 8949 (2025)