Adjusted Basis

Adjusted basis is an asset's cost basis, increased or decreased over time by various events, and it is the figure used to determine taxable gain or loss when the asset is sold. For real estate, the starting point is generally the purchase price plus acquisition costs such as title fees, recording fees, and certain closing costs. That basis is then increased by capital improvements that add value or prolong the property's life (a new roof, an addition, major systems), and decreased by depreciation deductions claimed each year, by casualty losses, and by certain credits. The result, the adjusted basis, is subtracted from the net sale price to compute the gain. Because depreciation reduces basis, a long-held rental property can have an adjusted basis far below both its purchase price and its market value, which is what produces a large taxable gain (including unrecaptured Section 1250 gain) on sale even if the property's value rose modestly. In a 1031 exchange, the adjusted basis of the relinquished property carries over (with adjustments for any boot and additional investment) into the replacement property rather than resetting to its purchase price, which is why the deferred gain is preserved rather than erased. By contrast, when property passes to heirs at death, the basis is generally stepped up to fair market value under Section 1014, eliminating the built-in gain. Tracking adjusted basis accurately over years of improvements and depreciation is essential to computing tax correctly and should be maintained with a tax advisor.