The adjusted basis of a property is the original cost of the property plus any capital improvements made, minus any depreciation taken. In a 1031 exchange, the adjusted basis of the property being sold is used to determine the amount of capital gains that will be subject to taxes.
Key-Takeaway
- The adjusted basis of a property is the original cost plus capital improvements minus depreciation.
- In a 1031 exchange, the adjusted basis of the property being sold is used to determine the amount of capital gains that will be subject to taxes.
Example
John bought a rental property for $200,000 and made $50,000 in capital improvements over the years. He also took $30,000 in depreciation on the property. His adjusted basis for the property would be $220,000 ($200,000 + $50,000 – $30,000). If John sells the property for $500,000, his capital gain would be $280,000 ($500,000 – $220,000) and subject to taxes unless he conducts a 1031 exchange and reinvests the sale proceeds in a replacement property.
Tips
- Keep accurate records of all capital improvements and depreciation taken on a property to ensure the adjusted basis is correctly calculated.
- Consider the potential capital gains taxes when making decisions about the sale of an investment property and whether a 1031 exchange may be a suitable option.
Recommendations
- Consult with a tax professional to fully understand the implications of the adjusted basis on capital gains taxes.
- Consider the use of a qualified intermediary (QI) when conducting a 1031 exchange to ensure that the exchange meets IRS requirements and to avoid actual receipt of the sale proceeds.
