Tax basis is the amount you have invested in an asset for tax purposes, and it is the number the IRS subtracts from your sale proceeds to figure out how much of the money is taxable profit. Every dollar of basis you can document is a dollar the government does not tax when you sell. That is why basis is worth understanding before you buy, while you own, and long before you sell.
The rules differ depending on how you got the asset and what happened to it while you held it. What follows walks through the common situations, starting with property you bought outright.
What Your Starting Basis Includes
For property you purchase, basis begins as cost.1Office of the Law Revision Counsel. 26 U.S.C. 1012 – Basis of Property-Cost Cost is more than the check you wrote to the seller. It covers cash paid, any debt you took on as part of the deal, and the fair market value of property or services you exchanged.
IRS Publication 551 also folds these purchase-related expenses into your basis:2Internal Revenue Service. Publication 551, Basis of Assets
- Sales tax and excise taxes charged on the purchase
- Freight and shipping to get the property to you
- Installation and testing costs to put the property into service
- Legal and recording fees, including title searches, transfer taxes, and revenue stamps
- Accounting fees that must be capitalized rather than deducted currently
A concrete example: buy a property for $400,000 and pay $12,000 in qualifying closing costs, and your starting basis is $412,000. When you sell years later, that extra $12,000 reduces your taxable gain dollar-for-dollar. Keep the closing statement, invoices, and receipts. They are the proof if the IRS ever questions your numbers.
How Basis Changes While You Own the Asset
Basis is not frozen at the original cost. Certain events push it up, others pull it down, and the running total is called your adjusted basis.3Office of the Law Revision Counsel. 26 U.S.C. 1016 – Adjustments to Basis
Capital Improvements Increase Basis
A capital improvement adds value, extends useful life, or adapts the property to a new use. Replacing a roof, adding a deck, and installing a new heating and cooling system all count. Money you spend on improvements gets added to your basis.
Repairs are different. Patching a hole in the wall or fixing a leaky faucet is routine maintenance, deducted (if deductible at all) in the year you pay for it rather than added to basis. The line between improvement and repair is where many homeowners lose money years later by throwing out the wrong receipts.
Depreciation Reduces Basis
If you use property in a business or rent it out, you recover part of your investment each year through depreciation. Residential rental property, for example, is depreciated over 27.5 years using the straight-line method.4Internal Revenue Service. Publication 527, Residential Rental Property Every year of depreciation lowers your basis, which means more of the eventual sale price becomes taxable gain.
An important trap: the IRS reduces your basis by the depreciation you were allowed to take, whether you actually took it or not. Skipping the deduction does not preserve basis. It just wastes the deduction.
Casualty Losses and Insurance
Casualty losses and insurance payments also cut basis. If a storm damages your rental property and insurance pays $30,000 toward the repair, your basis drops by that $30,000, because you have already been compensated for that piece of your investment.5Internal Revenue Service. Instructions for Form 4684 – Casualties and Thefts If insurance pays more than your adjusted basis, you have a gain, though you can often defer it by reinvesting in similar property.
Converting a Personal Asset to Business Use
When you turn a personal asset into a rental or business asset, your depreciation basis is the lower of your adjusted basis or the property’s fair market value on the conversion date.2Internal Revenue Service. Publication 551, Basis of Assets Buy a home for $300,000, watch its value fall to $250,000, then rent it out, and your depreciation basis is $250,000. This rule keeps you from depreciating value that was lost while you used the property personally. Only the building portion is depreciated, not the land.
Basis for Property You Didn’t Buy
Plenty of assets change hands without a purchase. Basis rules for those situations look nothing like the cost rules above.
Inherited Property Gets a Stepped-Up Basis
Property you inherit gets a stepped-up basis: your basis resets to the property’s fair market value on the date of death, not what the deceased owner originally paid.6Office of the Law Revision Counsel. 26 U.S.C. 1014 – Basis of Property Acquired From a Decedent If a parent bought stock for $10,000 decades ago and it was worth $200,000 at death, the heir’s basis is $200,000. Selling soon after for that amount produces close to zero taxable gain.
The fair market value usually comes from an appraisal or market data as of the date of death. The estate’s executor can elect an alternate valuation date six months after death instead. That election is irrevocable, is only available when it lowers both the gross estate and the total estate tax, and must be made on the estate tax return.7Office of the Law Revision Counsel. 26 U.S. Code 2032 – Alternate Valuation Any asset sold or distributed within that six-month window is valued on the date of sale or distribution instead.
In community property states, both halves of community property receive the step-up when one spouse dies, not just the deceased spouse’s half. The surviving spouse’s half also resets to fair market value, provided at least half of the community interest was included in the deceased spouse’s gross estate.8Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent This full step-up is one of the larger tax advantages of community property and is often overlooked by surviving spouses.
Gifted Property Uses Carryover Basis
A gift works the opposite way. The recipient generally takes the donor’s basis, which is why the rule is called carryover basis.9Office of the Law Revision Counsel. 26 U.S.C. 1015 – Basis of Property Acquired by Gifts and Transfers in Trust If your parent bought stock for $5,000 and gave it to you when it was worth $50,000, your basis is $5,000. The built-in appreciation follows the asset.
Gifts that dropped in value trigger a two-part rule. If the donor’s basis exceeds the fair market value on the date of the gift, you use the donor’s basis to figure a gain but the lower fair market value to figure a loss.10eCFR. 26 CFR 1.1015-1 – Basis of Property Acquired by Gift After December 31, 1920 Selling somewhere between those two numbers produces no gain and no loss. Example: donor’s basis $100,000, fair market value at the gift $90,000, sale at $95,000 is a tax non-event.
If the donor paid federal gift tax on the transfer, part of that tax can increase your basis. The increase equals the share of the gift tax attributable to the net appreciation: divide net appreciation by the total gift, then multiply by the gift tax paid.11eCFR. 26 CFR 1.1015-5 – Increased Basis for Gift Tax Paid The addition can never push basis above the gift’s fair market value.
Property Transferred in Divorce
Transfers between spouses during marriage, and between former spouses within one year of divorce or otherwise related to ending the marriage, are treated as gifts for basis purposes. No gain or loss is recognized, and the receiving spouse takes the transferring spouse’s adjusted basis.12Office of the Law Revision Counsel. 26 U.S. Code 1041 – Transfers of Property Between Spouses or Incident to Divorce
This matters during property division. Assets with the same market value can carry very different tax bills. A family home with a low basis and a brokerage account with a basis close to its current value look equal on paper, and are not equal after taxes. Compare after-tax values, not just current market prices.
Like-Kind Exchanges
A Section 1031 exchange lets you swap one piece of investment or business real estate for another and defer any gain. The tradeoff: your basis in the new property carries over from the old, rather than resetting to what the new property is worth.13Office of the Law Revision Counsel. 26 U.S. Code 1031 – Exchange of Real Property Held for Productive Use or Investment Exchange a building with a $200,000 adjusted basis for one worth $500,000 with no cash exchanged, and your basis in the new building is $200,000. The $300,000 in gain is deferred, not erased. It is now embedded in the replacement property.
If you receive cash or other non-qualifying property (called boot) in the exchange, you recognize gain up to the amount of boot. Basis in the new property equals the old basis, decreased by cash received and increased by the gain recognized. Since 2018, like-kind exchange treatment applies only to real property, not equipment or vehicles.
Wash Sales
Sell stock or securities at a loss and buy substantially identical shares within 30 days before or after the sale, and the wash sale rule disallows the loss.14Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss From Wash Sales of Stock or Securities The disallowed loss is not lost forever. It is added to the basis of the replacement shares, and your holding period from the old shares tacks onto the new ones.
Numbers make it concrete. Buy 100 shares for $5,000, sell for $3,000 (a $2,000 loss), and buy 100 identical shares a week later for $3,200. The loss is disallowed, and the new shares’ basis is $5,200 (the $3,200 purchase plus the $2,000 disallowed loss). The loss returns to you when you eventually sell the replacement shares without triggering another wash sale.
One trap: if you repurchase the shares in an IRA or Roth IRA instead of a taxable account, the disallowed loss is permanently forfeited. IRAs do not track basis the way taxable accounts do, so there is nothing for the loss to attach to.
Reinvested Dividends
Dividends you reinvest to buy more shares add to your total basis. The cash never touched your hand, but you paid income tax on those dividends when they were distributed. Leaving them out of your basis effectively taxes the same dollars twice when you sell.15Internal Revenue Service. Mutual Funds (Costs, Distributions, Etc.) Mutual fund investors with shares acquired at different prices can specifically identify which shares to sell, use first-in-first-out, or elect an average basis method.16Internal Revenue Service. Mutual Funds (Costs, Distributions, Etc.) Most brokerages handle this for shares acquired after 2011. Without adequate identification, the IRS defaults to first-in-first-out, which usually means the oldest and lowest-basis shares are treated as sold first.2Internal Revenue Service. Publication 551, Basis of Assets
How Basis Turns Into a Tax Number at Sale
At sale, the formula is: amount realized minus adjusted basis equals gain or loss. Amount realized is not simply the sticker price. It includes cash received, the fair market value of any property or services received, and any of your debts the buyer assumed, all reduced by selling expenses like commissions and legal fees.17Internal Revenue Service. Publication 544, Sales and Other Dispositions of Assets
Say you sell a rental property for $500,000. The buyer assumes your $50,000 mortgage and you pay $30,000 in commissions. Your amount realized is $520,000 ($500,000 plus the $50,000 mortgage assumed, minus $30,000 in selling costs). If years of depreciation have brought your adjusted basis down to $280,000, your gain is $240,000.
For a primary residence, federal law lets you exclude up to $250,000 of gain, or up to $500,000 if you are married and file jointly, provided you have owned and used the home as your principal residence for at least two of the five years before the sale.18Office of the Law Revision Counsel. 26 U.S.C. 121 – Exclusion of Gain From Sale of Principal Residence Married couples get the full $500,000 only if both spouses meet the use test and either spouse meets the ownership test. The exclusion is available once every two years. Basis still matters, because the exclusion applies to gain, and gain depends on adjusted basis. Twenty years of tracked improvements plus the exclusion can zero out the tax on an appreciated home.
Gains that are not excluded or deferred get taxed at capital gains rates that depend on how long you held the asset. Assets held more than one year qualify for long-term rates of 0%, 15%, or 20%, depending on income and filing status. Assets held one year or less are taxed as ordinary income.19Internal Revenue Service. Topic No. 409, Capital Gains and Losses Higher earners may also owe the 3.8% net investment income tax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly).20Internal Revenue Service. Topic No. 559, Net Investment Income Tax At these rates, a basis error on a large transaction can mean five-figure differences in tax owed.
Capital gains and losses are reported on Form 8949 and totaled on Schedule D.21Internal Revenue Service. 2025 Instructions for Form 8949 – Sales and Other Dispositions of Capital Assets
How Long to Keep Basis Records
The IRS says to keep records related to property until the statute of limitations expires for the tax year in which you dispose of it.22Internal Revenue Service. How Long Should I Keep Records? For most returns, that period is three years after filing. In practice, that means holding purchase records, improvement receipts, and depreciation schedules for as long as you own the asset, plus at least three more years after you sell and file the return reporting the sale.
Property received in a nontaxable exchange requires records from both the old and new property until you finally dispose of the replacement in a taxable transaction. Gifted property requires the donor’s original records too. For assets held for decades or passed between family members, that can mean recordkeeping obligations stretching 30 years or longer. Digital copies in more than one location are the most practical way to make sure the paper trail survives that long.