What Is Basis in Real Estate and How Is It Calculated?

Basis in real estate is the dollar amount the IRS treats as your investment in a property, and it is what your sale price is measured against to figure your taxable gain or deductible loss. You calculate it by starting with what you paid for the property (including the mortgage you took on) plus certain acquisition costs, then adjusting upward for capital improvements and downward for items like depreciation, insurance reimbursements, easement payments, and energy credits. The number you end up with on the day you sell is your adjusted basis.

How Your Starting Basis Is Set

Federal tax law defines basis as the cost of the property.¹ Cost means the full purchase price, including any mortgage debt you took on. Buy a house for $350,000 with $70,000 down and a $280,000 loan and your starting basis is $350,000, because the borrowed money is still part of what you paid.²

Several closing costs get added on top of the purchase price. Title insurance premiums, attorney fees for closing services, recording fees, transfer taxes, and survey costs all count. The common thread is that these are expenses of acquiring the property itself.

Closing Costs That Do Not Count

Costs tied to financing the purchase, rather than acquiring the property, stay out of basis. Loan origination fees, discount points, credit report fees, and lender-required appraisal fees do not increase your basis.³ Points on a purchase mortgage are generally deductible as interest instead, either in the year of purchase or spread over the life of the loan.⁴

Fire and casualty insurance premiums, rent paid to occupy the house before closing, and prepaid utility charges are also excluded.³ Money set aside in escrow for future property tax and insurance payments does not count either. Two details catch buyers off guard. If the seller pays discount points on your behalf, you reduce your basis by that amount even though you can deduct the points as mortgage interest.⁴ And any prorated real estate taxes you reimburse to the seller at closing are not part of your cost.¹

What Raises Your Basis

Every dollar spent on a genuine capital improvement adds to your adjusted basis, which shrinks your taxable gain when you sell.⁵ The IRS draws a firm line between improvements and repairs. An improvement adds value, extends the property’s useful life, or adapts it to a new use. A repair just keeps things in working order and does nothing to your basis.⁶

Work that qualifies as a capital improvement includes:

Structural additions such as finishing a basement, adding a bedroom or bathroom, or building a deck
Major system replacements like a new roof, central air conditioning, an upgraded electrical panel, or new plumbing
Site work such as paving a driveway, installing a septic system, or permanent landscaping
Energy upgrades including solar panel installation, new insulation, and replacement windows

Fixing a leaky faucet, repainting a room, or patching drywall does not change your basis. The distinction gets slippery at the margins: replacing a few broken shingles is a repair, but replacing the entire roof is an improvement. Keep every invoice for work of any real size, and write on it what was done and why. At sale, the IRS will want to see the paper.

What Lowers Your Basis

Several events push adjusted basis downward. Missing any of them means understating your gain when you sell.

Depreciation

If you use real estate to produce income, such as renting it out, you must claim depreciation each year.⁷ Residential rental property is depreciated over 27.5 years on the straight-line method.⁸ Each year’s deduction reduces your basis by the same amount. The trap for landlords: even if you never claimed depreciation, the IRS still reduces your basis by the amount you were allowed to take. Skipping the deduction on past returns does not preserve basis at sale.

Casualty Losses and Insurance

If fire, storm, or other casualty damages the property and you claim a tax deduction for the loss, your basis drops by the deducted amount. Insurance payouts have the same effect: any reimbursement for damage comes off your basis, because that money compensated you for lost value.⁹ What you then spend rebuilding or repairing goes back on as a capital improvement.

Easements and Energy Credits

Granting an easement (say, a permanent utility right-of-way across your land) reduces your basis by whatever you were paid.¹⁰ If the payment exceeds the basis of the affected portion, the excess is taxable gain.

Certain residential clean energy credits also cut basis. If you installed solar panels and claimed the residential clean energy credit, the portion of the cost covered by the credit does not stay in basis.¹¹ Spend $30,000 on a system and receive a $9,000 credit, and only $21,000 gets added to your adjusted basis.

When You Didn’t Buy the Property

Basis works differently when property comes to you by inheritance, gift, or divorce.

Inheritance

If you inherit real estate, your basis is generally the property’s fair market value on the date the previous owner died, not what they originally paid.¹² This step-up erases the unrealized appreciation that built up during the decedent’s lifetime. A house your parent bought for $80,000 in 1985 that was worth $450,000 on their date of death has a basis of $450,000 in your hands. Sell it the next month for $455,000 and the taxable gain is $5,000.

If a federal estate tax return was filed, your basis must be consistent with the value reported on it.¹³ Inherited property is automatically treated as held long-term for capital gains purposes, even if you sell within months.¹⁴

Gifts

Real estate you receive as a gift generally keeps the donor’s adjusted basis.¹⁵ This carryover basis means the donor’s unrealized gain travels to you. Uncle bought a rental for $150,000 twenty years ago and gifts it to you at a fair market value of $400,000; your basis is still $150,000, and the built-in gain is yours to eventually pay tax on.

One wrinkle: if the donor’s adjusted basis is higher than the property’s fair market value on the gift date and you later sell at a loss, your basis for measuring that loss is the lower fair market value on the gift date. The donor’s basis can also be increased, but not above the fair market value on the gift date, by any gift tax the donor paid on the transfer.¹⁵

Divorce

Property transferred between spouses as part of a divorce is treated like a gift for basis purposes. The receiving spouse takes over the transferring spouse’s adjusted basis, and no gain or loss is recognized at the transfer. The rule applies if the transfer happens within one year of the divorce or is related to the end of the marriage.¹⁶ That has real consequences at the negotiating table: if one spouse keeps the house with a $200,000 basis and the other takes a $400,000 brokerage account with a $380,000 basis, the assets look equal but the house carries a much larger embedded tax bill.

How Basis Turns Into Tax at Sale

The formula is straightforward. Subtract your adjusted basis from your amount realized (the selling price minus selling costs like agent commissions, advertising, staging, and closing legal fees). A positive result is a gain, a negative result is a loss.

Real estate held for more than one year qualifies for long-term capital gains rates, which are lower than ordinary income rates for most taxpayers. Property sold within a year of purchase is taxed as ordinary income.¹⁴ Losses on a personal residence are not deductible. Losses on investment or rental property can offset other capital gains and, within limits, ordinary income.

Depreciation Recapture on Rentals

Selling a property you depreciated triggers a specific tax that surprises many first-time sellers. The gain attributable to prior depreciation deductions (unrecaptured Section 1250 gain) is taxed at a rate of up to 25%, regardless of your regular income bracket.¹⁷ Any gain above the recapture amount is taxed at standard long-term capital gains rates. You benefit from depreciation while you own the property, but a portion comes back at sale. This is a common reason investors use a Section 1031 like-kind exchange to defer the recapture tax.

The Section 121 Exclusion on a Primary Home

Most homeowners selling a primary residence never owe federal tax on the gain. Single filers can exclude up to $250,000 in gain and married couples filing jointly up to $500,000.³ To qualify, you must have owned and used the home as your principal residence for at least two of the five years before the sale. Those two years don’t need to be consecutive, only add up to 24 months (or 730 days) within the five-year window.¹⁸

A partial exclusion may be available if you fell short of two years because of a job move, a health issue, or an unforeseen circumstance. The amount is prorated for how much of the two-year period you actually met.¹⁹ Even with the exclusion, basis still matters. A homeowner with $600,000 of gain and a $500,000 exclusion owes tax on the remaining $100,000, and every documented improvement over the years directly reduces that leftover.

Proving Your Basis

The IRS puts the burden of proving basis on you. To shift any part of that burden in a dispute, you need to show you kept adequate records and cooperated with the agency’s requests.²⁰ In practice, hold onto:

Your original closing statement
Receipts and contracts for every capital improvement
Records of casualty losses and insurance payments
Depreciation schedules for any period the property was rented

When you sell, the settlement agent files Form 1099-S reporting the gross proceeds to the IRS.²¹ You report the sale on Form 8949, listing proceeds and adjusted basis, and carry the totals to Schedule D.²² The IRS sees the 1099-S figure but not your basis, so mismatches tend to generate notices.

Keep your basis records for at least three years after filing the return that reports the sale, the standard IRS audit window. Many tax advisors recommend keeping property records permanently. A home you own for thirty years accumulates a long chain of adjustments that is nearly impossible to reconstruct from scratch.

1
Office of the Law Revision Counsel. 26 USC 1012 Basis of Property-Cost
2
eCFR. 26 CFR 1.1012-1 Basis of Property
3
Internal Revenue Service. Selling Your Home
4
Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
5
Office of the Law Revision Counsel. 26 USC 1016 Adjustments to Basis
6
eCFR. 26 CFR 1.1016-2 Items Properly Chargeable to Capital Account
7
Office of the Law Revision Counsel. 26 USC 167 Depreciation
8
Office of the Law Revision Counsel. 26 USC 168 Accelerated Cost Recovery System
9
Internal Revenue Service. Publication 547 (2025), Casualties, Disasters, and Thefts
10
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
11
Office of the Law Revision Counsel. 26 US Code 25D – Residential Clean Energy Credit
12
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
13
Federal Register. Consistent Basis Reporting Between Estate and Person Acquiring Property From Decedent
14
Office of the Law Revision Counsel. 26 US Code 1223 – Holding Period of Property
15
Office of the Law Revision Counsel. 26 USC 1015 Basis of Property Acquired by Gifts and Transfers in Trust
16
Office of the Law Revision Counsel. 26 US Code 1041 – Transfers of Property Between Spouses or Incident to Divorce
17
Internal Revenue Service. Property (Basis, Sale of Home, Etc.) 5
18
eCFR. 26 CFR 1.121-1 – Exclusion of Gain From Sale or Exchange of a Principal Residence
19
Office of the Law Revision Counsel. 26 US Code 121 – Exclusion of Gain From Sale of Principal Residence
20
Office of the Law Revision Counsel. 26 US Code 7491 – Burden of Proof
21
Internal Revenue Service. Instructions for Form 1099-S Proceeds From Real Estate Transactions
22
Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets