We wanted to provide a newsletter about a crucial tax topic for real estate buying and selling considerations: basis. “Basis” is the amalgamation of your investment in an asset, and it will determine whether you are subject to tax on a sale.
Calculating basis can be tricky, as it can change over time. We recommend that our clients track basis adjustments throughout the life of any given investment. Diligent tracking can reward you with a substantially lower tax liability. We have listed some items you should record to keep track of changes to your basis as you purchase, improve, and sell your home.
Purchase Price and Closing Costs
The most important figure affecting your home’s basis is the purchase price. This includes your down payment and any debt, such as a mortgage. This also includes certain fees and closing costs associated with the purchase of your home. Be sure to save the full escrow statement provided to you by your escrow officer at the time of closing. The escrow statement is the starting point in determining your home basis.
If you contracted to have your house built on the land you own, your basis is the cost of the land plus the amount you paid to construct the house. This includes labor, materials, architect’s fees, building permit charges, utility meter and connections charges, and legal fees directly connected with building the house. We strongly advise that you save all invoices for any of the aforementioned charges. Contractors often provide a work summary sheet with detailed cost information. These documents prove useful when substantiating home basis calculations. Basis does not include the value of your own labor or any other unpaid labor.
Costs Inherited from the Seller
You can include in your basis total any amounts the seller owes that you agree to pay (as long as the seller does not reimburse you), such as: real estate taxes owed up through the day before the sale date, back interest owed by the seller, the seller’s title recording or mortgage fees, charges for improvements or repairs that are the seller’s responsibility (e.g. lead paint removal), and sales commissions (e.g. payment to the seller’s real estate agent).
Improvements add value to your home, prolong its useful life, and adapt it for new uses. You should add the cost of additions and improvements to the basis of your property. Examples include additions or improvements of new or existing rooms, lawn and grounds, exterior/interior refurbishments, insultation, and home systems such as HVAC and plumbing.
Please note that minor general repairs are not included in basis unless they are part of a larger project. For example, replacing a broken windowpane would not qualify, but replacing all windows in your home counts as a qualifying improvement, the cost of which may be added to your home’s basis. Be sure to retain any invoices related to home improvements for your CPA to review in the event that they may qualify.
Energy Credits and Subsidies
If you included in your basis the cost of any energy-related improvements (such as a solar energy system), and you received any tax credits or subsidies related to those improvements, you must subtract those credits or subsidies from your total basis.
1031 Exchange Considerations
When you trade your investment property for a new one, taxing authorities treat the event as if you have sold your property and purchased a new one. Your sale price is the trade-in value you received for your property plus any outstanding mortgage or other debt. If you paid for your property by trading other property for it, the starting basis of your property is usually the fair market value of the property you traded. In general, a Section 1031 exchange can only be made with investment properties and not your principal or secondary residences.
Plan for Minimizing Your Tax Liability
Be sure to keep track of all pertinent documentation of basis items in order to substantiate your basis. Save receipts, invoices, contractor paperwork, and other records for improvements and additions you make to your property. When you sell your home, proper documentation is crucial for establishing the amount of your gain or loss on the property.
We hope you will consider the general guidelines we have presented in this article, but we strongly recommend that you work closely with your CPA to assess your specific situation. We would be happy to discuss the best plan to minimize your taxes if and when you decided to sell your home.
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