Cost Basis

Cost basis is the amount the tax law treats as your investment in a property, and it is the starting point for calculating gain or loss when you sell. For real estate, the original basis generally equals the purchase price plus closing costs and capital improvements, increased over time by additional improvements and decreased by depreciation deductions and any casualty losses. The difference between the sale price (less selling costs) and the adjusted basis is the gain that may be subject to capital gains tax and depreciation recapture. Cost basis is central to tax-deferral strategies. In a 1031 exchange, the deferred gain is preserved by carrying the old property's basis forward into the replacement property, adjusted for any additional cash invested or boot received, so the replacement property typically has a low carryover basis. The same carryover concept applies to property contributed to an UPREIT for OP units. Because a low basis means a large built-in gain, many long-term investors hold appreciated, deferred property until death, when heirs receive a stepped-up basis equal to the fair market value at the date of death, potentially eliminating the accumulated deferred gain. Understanding basis is essential to projecting the true after-tax outcome of any sale or exchange.