Rental Property Cost Basis

How to calculate cost basis on a rental property starts with what you paid to acquire it. Publication 551 says the basis of property you buy is usually its cost. Cost is the amount you pay in cash, debt obligations, other property, or services. For real estate, certain settlement costs join that cost. Capital improvements join it later. The loan payoff, the list price, and the cash you wired are three different numbers. Cost basis is the capital account you will depreciate in part and, someday, compare with the sale.

These figures are an illustration. They are not a tax opinion or an appraisal. An inquiry is not an approval.

How to Calculate Cost Basis on a Rental Property

Add three groups, and keep them labeled.

The purchase price, including any debt you take on to buy the property.
The settlement costs Publication 551 includes in basis.
Capital improvements you pay for after the purchase, each in its own account.

Leave out costs Publication 551 assigns to getting the loan, and leave out amounts you are allowed to deduct currently as repairs.

Take a purchase at a contract price of $345,000. You wire $75,000 and you sign a $270,000 note. Publication 551 includes the debt in basis. The example in that publication is the same shape: cash plus the mortgage you assume or become liable for. Your starting price is $345,000, not the $75,000 check.

Settlement costs that are part of buying the property, even if you had paid cash, can include abstract fees, charges for installing utility services, legal fees for the title work and the deed, recording fees, surveys, transfer taxes, and owner’s title insurance. Publication 551 also includes amounts the seller owes that you agree to pay, such as back taxes, when those amounts are part of what you pay to acquire the property.

In this illustration the includable closing costs are:

Owner’s title insurance: $1,900
Recording fees: $150
Survey: $700
Transfer tax: $1,250
Legal fees for the deed and title work: $1,000

Those sum to $5,000. Cost basis at acquisition is $350,000.

Item	In basis?	Amount
Contract price, cash plus new loan	Yes	$345,000
Owner’s title policy, recording, survey, transfer tax, deed counsel	Yes	$5,000
Cost basis at purchase		$350,000
Lender appraisal, origination, credit report	No	left out
Prepaid insurance and tax escrow	No	left out

Cash to close on an investment property is the wire. DSCR loan closing costs are the financing charges a loan file itemizes. Some of those dollars enter basis. Some never do. The closing statement has to be split with Publication 551 in hand, not totaled into one “closing cost” bucket.

Closing Costs That Stay Out of Basis

Publication 551 says you cannot include in basis the fees and costs of getting a loan. A purchase cost is one you would pay even in a cash deal. Loan costs are not that.

The publication’s list of excluded items includes casualty insurance premiums, rent for occupancy before closing, charges for utilities related to occupancy before closing, and charges connected with getting a loan. Those loan charges include points, mortgage insurance premiums, loan assumption fees, the cost of a credit report, and fees for an appraisal the lender requires. Fees for refinancing a mortgage stay out of the property’s basis as well. Points on a rental loan are generally deducted over the term of the loan. They are not added to the building.

Amounts placed in escrow for the future payment of taxes and insurance are not basis. You have not spent them on the property yet. When the escrow later pays the tax bill, that payment is the tax, handled under the tax rules, not a second addition to what you paid the seller.

Watch double counting. If the contract price already includes a seller credit, or the seller’s delinquent tax was added to the price on the settlement statement, do not add that tax again. Publication 551’s rule is about amounts you pay that are not already inside the price. Read the lines.

Back taxes the seller owed, which you pay and the seller does not reimburse, are part of basis. You do not also deduct them as taxes. If you reimburse the seller for taxes the seller paid for you, Publication 551 says you can usually deduct that amount and you do not add it to basis.

Capital Improvements Raise Basis Later

Publication 551 says you increase basis by items properly added to a capital account. That includes the cost of improvements with a useful life of more than one year. The publication’s examples include putting an addition on a property, replacing an entire roof, paving a driveway, installing central air, and rewiring. Assessments for local improvements such as streets and sidewalks can increase basis too. You do not deduct those assessments as taxes.

A roof that costs $14,000 and meets the improvement test is a new capital account. Total capital accounts are then $364,000: the $350,000 acquisition plus the $14,000 roof. Publication 551 says to keep a separate account for each addition or improvement and to depreciate it under the rules that apply when you place it in service. The roof does not disappear into the land line.

Repairs and maintenance you can deduct currently do not increase basis. Publication 551 is explicit: amounts paid for incidental repairs or maintenance that are deductible as business expenses are not added to basis. A pipe patch you deduct is gone from the capital account on purpose. If you deduct it and also add it to basis, you have used the same dollars twice. The line between those invoices is repair versus improvement on a rental.

Publication 551 also says not to include the value of your own labor, or any other labor you did not pay for, in the basis of property you construct. Materials you pay for can be an improvement cost. Hours you do not pay yourself are not an amount you paid. A contractor invoice is basis if the work is an improvement. Your unpaid Saturday is not.

Land Sits Inside the Total

The $350,000 includes land and building. Cost basis of the whole property is that total. Depreciation uses only the building portion and, later, the roof. The split, using assessed values or fair market values, is on the depreciation page. Do not drop the land out of cost basis. Do not depreciate it either. Both sentences can be true because they talk about two different chores: recording what you paid, and recovering only the part that wears out.

Adjusted basis comes after cost basis. Publication 551 says you adjust basis before you figure gain or loss, or before you figure depreciation. Depreciation allowed or allowable is a decrease. Casualty loss deductions and insurance reimbursements can decrease basis. The capital improvement is an increase. When you sell, the gain uses adjusted basis, not the original $350,000 alone. That sale math is capital gains tax on rental property.

Property you inherited, or received by gift, can have a basis other than a price you paid. Publication 551 covers those starting points. Whether to keep an inherited rental is where that case is discussed for an owner who is deciding what to do with the property. The formula on this page is for a rental you bought.

Keep the settlement statement, the assessment or appraisal support for the land split, and every improvement invoice. You will need the improvement cost when you depreciate the roof and again when you sell. A missing invoice does not become zero basis, and it does not become whatever number is convenient at the sale. Reconstruct it while the contractor still has a copy.

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Frequently Asked Questions

Does the mortgage count toward cost basis?

Yes. Publication 551 includes the amount you pay plus the debt you become liable for. A $75,000 down payment and a $270,000 loan produce a $345,000 price in this illustration, before the closing costs that belong in basis. Basis is not the down payment. The down payment is the cash portion of the price.

Which closing costs increase the basis of a rental?

Publication 551 includes purchase costs such as owner’s title insurance, recording fees, surveys, transfer taxes, and legal fees for the deed. It excludes loan origination, points, a lender-required appraisal, credit reports, prepaid insurance, and escrow deposits for future taxes and insurance. Split the closing statement. Do not add the entire “cash to close” figure.

Do repairs increase cost basis?

Deductible repairs and maintenance do not. Publication 551 says those amounts are not added to basis. Capital improvements do increase basis. A new roof is the publication’s own example of an increase. The invoice has to qualify as an improvement before you add it. The repair-versus-improvement page is the test.

Is cost basis the same number I use to compute gain on a sale?

Cost basis is the starting account. Adjusted basis is cost basis plus later capital improvements, minus depreciation allowed or allowable and other required decreases. The sale uses adjusted basis. If you have depreciated the building for several years, the gain computation starts from a number smaller than the original $350,000, then adds any improvements still in the account.

What if I refinance after I buy?

A later refinance changes the loan. Publication 551 says fees for refinancing are not added to the property’s basis. Points on the new loan are handled as loan costs, generally over the term of that loan. The building’s cost basis stays the acquisition number plus capital improvements, unless some other basis adjustment applies. Borrowing more does not step the basis up to the new loan amount.