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Adjusted Basis Formula
The adjusted basis of an asset starts with its original purchase price, adds the cost of any capital improvements, and subtracts accumulated depreciation. This final number is what the IRS uses to determine your taxable gain or loss when you sell.
AB = PP + I − D
How It Works
The adjusted basis of an asset starts with its original purchase price, adds the cost of any capital improvements, and subtracts accumulated depreciation. This final number is what the IRS uses to determine your taxable gain or loss when you sell. For real estate, improvements include renovations like a new roof or HVAC system, while routine maintenance does not count. Depreciation is claimed annually on rental and business property, reducing the basis over time.
Example Problem
You buy a rental property for $250,000, spend $40,000 on a kitchen remodel, and claim $30,000 in depreciation over several years. What is the adjusted basis?
- Purchase Price: $250,000
- Add improvements: $250,000 + $40,000 = $290,000
- Subtract depreciation: $290,000 − $30,000 = $260,000
If you later sell the property for $320,000, your taxable gain is $320,000 − $260,000 = $60,000.
When to Use Each Variable
- Solve for Adjusted Basis — when you know the purchase price, improvements, and depreciation and need to find your tax basis before selling, e.g., calculating capital gains on a rental property.
- Solve for Purchase Price — when you know the adjusted basis, improvements, and depreciation and need to back-calculate the original cost, e.g., reconstructing records for inherited property.
- Solve for Improvements — when you know the adjusted basis, purchase price, and depreciation and need to determine how much was spent on capital improvements.
- Solve for Depreciation — when you know the adjusted basis, purchase price, and improvements and need to calculate total accumulated depreciation, e.g., verifying IRS depreciation schedules.
Key Concepts
Adjusted basis is the IRS-recognized cost of an asset for tax purposes. It starts at the original purchase price, increases with qualifying capital improvements (renovations, additions, major systems), and decreases with depreciation claimed over the holding period. The difference between the sale price and adjusted basis determines the taxable capital gain or loss.
Applications
- Real estate investing: calculating taxable gain when selling a rental property after years of depreciation
- Tax planning: estimating the tax impact of a 1031 exchange by comparing adjusted basis to replacement property value
- Estate planning: determining stepped-up basis for inherited property to minimize beneficiary tax liability
- Business asset management: tracking adjusted basis of equipment and vehicles for depreciation schedules
Common Mistakes
- Counting routine maintenance as a capital improvement — painting, minor plumbing repairs, and landscaping maintenance do not increase basis; only improvements that add value or extend useful life qualify
- Forgetting to subtract depreciation actually claimed (or allowed) — the IRS reduces your basis by the depreciation you were entitled to, even if you failed to claim it on your returns
- Using the original purchase price instead of adjusted basis when calculating gain — this overstates or understates your taxable profit depending on net improvements vs. depreciation
Frequently Asked Questions
What is adjusted basis in real estate?
Adjusted basis is the tax-recognized cost of a property after accounting for improvements and depreciation. It determines how much capital gains tax you owe when you sell. A higher adjusted basis means a smaller taxable gain.
What counts as a capital improvement vs. a repair?
Capital improvements add value, extend the useful life, or adapt a property to a new use. Examples include adding a deck ($15,000) or replacing a roof ($12,000). Routine repairs like fixing a leaky faucet do not increase basis.
How does depreciation affect adjusted basis?
Depreciation lowers your adjusted basis each year, which increases your taxable gain when you sell. For residential rental property, the IRS allows straight-line depreciation over 27.5 years. A $275,000 building depreciates by $10,000 per year.
Can adjusted basis be negative?
In practice, adjusted basis should not go below zero. If accumulated depreciation exceeds the purchase price plus improvements, you would typically stop depreciating the asset. The IRS requires depreciation recapture when you sell.
Reference: IRS Publication 551 — Basis of Assets. Internal Revenue Service.
Related Calculators
- Depreciation Calculator — compute straight-line depreciation for any asset.
- Gain on Sale Calculator — find capital gains or losses from selling an asset.
- Capitalization Rate Calculator — evaluate investment property returns.
- Loan to Value Ratio Calculator — determine LTV based on appraised value and loan balance.
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Reference: IRS Publication 551 — Basis of Assets. Internal Revenue Service.