Basis of Depreciable Property
The basis of property used in a rental activity is generally its adjusted basis when you place it in service in that activity. This is its cost or other basis when you acquired it, adjusted for certain items occurring before you place it in service in the rental activity.
If you depreciate your property under MACRS, you may also have to reduce your basis by certain deductions and credits with respect to the property.
Basis and adjusted basis are explained in the following discussions.
If you used the property for personal purposes before changing it to rental use, its basis for depreciation is the lesser of its adjusted basis or its FMV when you change it to rental use. See Basis of Property Changed to Rental Use in chapter 4.
The basis of the property you buy is usually its cost. The cost is the amount you pay for it in cash, in debt obligation, in other property, or in services. Your cost also includes amounts you pay for:
- Sales tax charged on the purchase (but see Exception next),
- Freight charges to obtain the property, and
- Installation and testing charges.
Exception. If you deducted state and local general sales taxes as an itemized deduction on Schedule A (Form 1040), don’t include as part of your cost basis the sales taxes you deducted. Such taxes were deductible before 1987 and after 2003.
Loans with low or no interest.
If you buy property on any payment plan that charges little or no interest, the basis of your property is your stated purchase price, less the amount considered to be unstated interest. See Unstated Interest and Original Issue Discount (OID) in Pub. 537, Installment Sales.
If you buy real property, such as a building and land, certain fees and other expenses you pay are part of your cost basis in the property.
Real estate taxes.
If you buy real property and agree to pay real estate taxes on it that were owed by the seller and the seller doesn’t reimburse you, the taxes you pay are treated as part of your basis in the property. You can’t deduct them as taxes paid.
If you reimburse the seller for real estate taxes the seller paid for you, you can usually deduct that amount. Don’t include that amount in your basis in the property.
Settlement fees and other costs.
- Abstract fees.
- Charges for installing utility services.
- Legal fees.
- Recording fees.
- Transfer taxes.
- Title insurance.
- Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.
The following are settlement fees and closing costs you can’t include in your basis in the property.
- Fire insurance premiums.
- Rent or other charges relating to occupancy of the property before closing.
- Charges connected with getting or refinancing a loan, such as:
- Points (discount points, loan origination fees),
- Loan assumption fees,
- Cost of a credit report, and
- Fees for an appraisal required by a lender.
Also, don’t include amounts placed in escrow for the future payment of items such as taxes and insurance.
Assumption of a mortgage.
Example. You buy a building for $60,000 cash and assume a mortgage of $240,000 on it. Your basis is $300,000.
Separating cost of land and buildings.
If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the FMV of that asset to the FMV of the whole property at the time you buy it.
If you aren’t certain of the FMVs of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes.
You buy a house and land for $200,000. The purchase contract doesn’t specify how much of the purchase price is for the house and how much is for the land.
The latest real estate tax assessment on the property was based on an assessed value of $160,000, of which $136,000 was for the house and $24,000 was for the land.
You can allocate 85% ($136,000 ÷ $160,000) of the purchase price to the house and 15% ($24,000 ÷ $160,000) of the purchase price to the land.
Your basis in the house is $170,000 (85% of $200,000) and your basis in the land is $30,000 (15% of $200,000).