Adjusted basis is a calculation that might mean little to a real estate investor until he or she sells a rental property; then it plays a major role because it always determines how much the investor will actually gain as a result of the sale.
The objective for real estate investing for any typical investor is, of course, to buy income property low and then sell it high in order to realize a gain on the sale.
But in order to calculate the gain, it is necessary for the investor to know his or her adjusted basis.
In an effort to help you understand this process, this article will show you how to make the computation for the basis as well as the computation for gain on sale. We have also included an example that will walk you through the process and hopefully further clarify it for you.
Adjust Basis
This represents the beginning basis of the investment property (i.e., the original cost of the property).
Then to that are added costs for capital improvements (made during the holding period), plus costs of sale (i.e., costs at re-sale), less accumulated depreciation (taken during the holding period on both the structures and capital additions).
Original Basis (Purchase Price)
+ Capital Improvements
+ Costs of Sale (at re-sale)
– Cumulative Depreciation (Real Estate)
– Cumulative Depreciation (Capital Improvements)
= Adjusted Basis at Sale
Example
Say you purchase a rental income property for $300,000. The following year you make $75,000 in capital improvements. By the time you sell the property you have also taken $21,000 in depreciation for the real estate and $4,000 on the additions. You wind up paying $25,000 to sell the property (real estate commissions and closing costs). The computation would go like this.
$300,000 (original cost)
+ 75,000 (capital improvements)
+ 25,000 (cost of sale)
– 21,000 (depreciation taken for property)
– 4,000 (depreciation taken for additions)
= $375,000 (adjusted basis)
Gain on Sale
Once the basis is computed you would use it to calculate the gain on sale.
Selling Price
– Adjusted Basis
= Gain on Sale
Example
Okay, now let’s assume you sell the property for $500,000 and want to know what you can expect to gain on the sale. If we use the calculations made above here’s your bottom line.
$500,000
– 375,000
= $125,000
So You Know
It should be noted that ProAPOD Real Estate Investment Software does automatically compute the Adjusted Basis and Gain on Sale in it’s Investor 8 and Executive 10 software solutions.
