- 1). Determine your initial tax basis -- quite simply, the price you paid for the property. For example, if you purchase a condo as an investment for $100,000, your initial tax basis on the property is $100,000.
- 2). Add closing cost adjustments. Some of the closing costs that you incur on the purchase of real estate increase your tax basis in the property. These include abstract of title fees, charges for installing utility services, legal fees, recording fees, surveys, transfer taxes, owner's title insurance and any back taxes paid on behalf of the seller. Insurance costs and fees related to the mortgage (including origination points) are not allowable basis adjustments.
- 3). Calculate improvements to the property. Any capital improvements made to the property with a useful life of one year or more are allowable adjustments to the property's tax basis. Some examples of allowable improvements include additions to the property, replacing an entire roof, paving the driveway, installing central air conditioning and similar major improvements to the property. Any legal fees, permitting fees and zoning fees paid to accomplish the improvements are also allowable adjustments to the property's tax basis.
- 4). Maintain good records. This is a critical step. The easiest way to maintain records of adjustments to a property's tax basis is to start a legal-size folder on the property when you purchase it. The first document to go into the folder is the HUD-1 form you receive at closing which lists the property purchase price and all the associated closing costs in an itemized format. From that point on, keep a record of all major expenses and improvements related to the property.
- 5). Turn the records over to your accountant when you sell the property. Your accountant will calculate your correct tax basis in the property and make sure you receive all the allowable adjustments to lower your capital gains tax on the sale. If your accountant's determination of your tax basis is different from your own, the discrepancy is easy to find by going back to the property's records.
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