Adjusted Basis Formula
The adjusted basis of an asset starts with its original purchase price, adds the cost of any capital improvements, and subtracts accumulated depreciation. This final number is what the IRS uses to determine your taxable gain or loss when you sell.
AB = PP + I - D
How It Works
The adjusted basis of an asset starts with its original purchase price, adds the cost of any capital improvements, and subtracts accumulated depreciation. This final number is what the IRS uses to determine your taxable gain or loss when you sell. For real estate, improvements include renovations like a new roof or HVAC system, while routine maintenance does not count. Depreciation is claimed annually on rental and business property, reducing the basis over time.
Example Problem
You buy a rental property for $250,000, spend $40,000 on a kitchen remodel, and claim $30,000 in depreciation over several years. What is the adjusted basis?
- Identify the known values: purchase price = $250,000, improvements = $40,000, depreciation = $30,000.
- Determine what we are solving for: the adjusted basis (AB).
- Write the adjusted basis formula: AB = PP + I - D.
- Substitute the known values: AB = $250,000 + $40,000 - $30,000.
- Add the purchase price and improvements: $250,000 + $40,000 = $290,000.
- Subtract the depreciation: $290,000 - $30,000 = $260,000. The adjusted basis is $260,000.
If you later sell the property for $320,000, your taxable gain is $320,000 - $260,000 = $60,000.
When to Use Each Variable
- Solve for Adjusted Basis — when you know the purchase price, improvements, and depreciation and need to find your tax basis before selling, e.g., calculating capital gains on a rental property.
- Solve for Purchase Price — when you know the adjusted basis, improvements, and depreciation and need to back-calculate the original cost, e.g., reconstructing records for inherited property.
- Solve for Improvements — when you know the adjusted basis, purchase price, and depreciation and need to determine how much was spent on capital improvements.
- Solve for Depreciation — when you know the adjusted basis, purchase price, and improvements and need to calculate total accumulated depreciation, e.g., verifying IRS depreciation schedules.
Key Concepts
Adjusted basis is the IRS-recognized cost of an asset for tax purposes. It starts at the original purchase price, increases with qualifying capital improvements (renovations, additions, major systems), and decreases with depreciation claimed over the holding period. The difference between the sale price and adjusted basis determines the taxable capital gain or loss.
Applications
- Real estate investing: calculating taxable gain when selling a rental property after years of depreciation
- Tax planning: estimating the tax impact of a 1031 exchange by comparing adjusted basis to replacement property value
- Estate planning: determining stepped-up basis for inherited property to minimize beneficiary tax liability
- Business asset management: tracking adjusted basis of equipment and vehicles for depreciation schedules
Common Mistakes
- Counting routine maintenance as a capital improvement — painting, minor plumbing repairs, and landscaping maintenance do not increase basis; only improvements that add value or extend useful life qualify
- Forgetting to subtract depreciation actually claimed (or allowed) — the IRS reduces your basis by the depreciation you were entitled to, even if you failed to claim it on your returns
- Using the original purchase price instead of adjusted basis when calculating gain — this overstates or understates your taxable profit depending on net improvements vs. depreciation
Frequently Asked Questions
How do you calculate adjusted basis?
Start with the original purchase price, add the cost of all qualifying capital improvements, and subtract any accumulated depreciation. The formula is AB = PP + I - D. For example, a $300,000 property with $50,000 in improvements and $40,000 in depreciation has an adjusted basis of $310,000.
What is the formula for adjusted basis?
The formula is Adjusted Basis = Purchase Price + Improvements - Depreciation (AB = PP + I - D). You can rearrange it to solve for any variable. For instance, Depreciation = Purchase Price + Improvements - Adjusted Basis.
Why does adjusted basis matter when you sell a property?
Adjusted basis determines your taxable capital gain or loss. When you sell, the IRS calculates your gain as Sale Price minus Adjusted Basis. A higher adjusted basis means a smaller taxable gain and less tax owed. Tracking improvements carefully can save thousands in taxes.
What improvements increase your property's adjusted basis?
Capital improvements that add value, extend the useful life, or adapt the property to a new use increase your basis. Examples include a new roof ($12,000), kitchen remodel ($25,000), HVAC replacement ($8,000), or adding a bathroom. Routine repairs like fixing a leaky faucet or repainting do not qualify.
What is adjusted basis in real estate?
Adjusted basis is the tax-recognized cost of a property after accounting for improvements and depreciation. It determines how much capital gains tax you owe when you sell. A higher adjusted basis means a smaller taxable gain.
How does depreciation affect adjusted basis?
Depreciation lowers your adjusted basis each year, which increases your taxable gain when you sell. For residential rental property, the IRS allows straight-line depreciation over 27.5 years. A $275,000 building depreciates by $10,000 per year.
Can adjusted basis be negative?
In practice, adjusted basis should not go below zero. If accumulated depreciation exceeds the purchase price plus improvements, you would typically stop depreciating the asset. The IRS requires depreciation recapture at a 25% tax rate when you sell.
Reference: IRS Publication 551 — Basis of Assets. Internal Revenue Service.
Adjusted Basis Formula
The adjusted basis formula determines the tax-recognized cost of an asset:
AB = PP + I − D
Where:
- AB — Adjusted Basis, the tax-recognized value of the asset ($)
- PP — Purchase Price, the original acquisition cost ($)
- I — Improvements, the total cost of capital improvements ($)
- D — Accumulated Depreciation, the total depreciation claimed over the holding period ($)
The formula applies to real estate, business equipment, and any depreciable asset. For residential rental property, the IRS allows straight-line depreciation over 27.5 years. Capital improvements must add value or extend useful life — routine maintenance does not qualify.
Worked Examples
Tax Planning
What is the adjusted basis of a home you plan to sell?
You bought your home for $350,000 and spent $45,000 on a kitchen remodel and $20,000 on a new roof. No depreciation applies (primary residence).
- Purchase Price: $350,000
- Total Improvements: $45,000 + $20,000 = $65,000
- Depreciation: $0 (primary residence)
- AB = $350,000 + $65,000 − $0
- Adjusted Basis = $415,000
If you sell for $550,000, your taxable gain is $550,000 − $415,000 = $135,000 (before the home sale exclusion).
Rental Property
What is the adjusted basis after 10 years of depreciation?
A rental duplex was purchased for $400,000 (building value $320,000). After 10 years of straight-line depreciation over 27.5 years, with $30,000 in capital improvements.
- Purchase Price: $400,000
- Improvements: $30,000
- Depreciation: $320,000 / 27.5 x 10 = $116,364
- AB = $400,000 + $30,000 − $116,364
- Adjusted Basis = $313,636
The IRS requires depreciation recapture at 25% when you sell, so the $116,364 in depreciation will be taxed even if you sell at a loss relative to the original price.
Estate Planning
How much depreciation has been claimed on inherited property?
You inherited a property with a stepped-up basis of $500,000. After $40,000 in improvements, the current adjusted basis is $490,000. How much depreciation has been claimed?
- Rearrange: D = PP + I − AB
- D = $500,000 + $40,000 − $490,000
- Depreciation = $50,000
The stepped-up basis at inheritance resets the cost basis to fair market value at the date of death, potentially eliminating decades of unrealized gains.
Related Calculators
- Depreciation Calculator — compute straight-line depreciation for any asset.
- Gain on Sale Calculator — find capital gains or losses from selling an asset.
- Capitalization Rate Calculator — evaluate investment property returns.
- Loan to Value Ratio Calculator — determine LTV based on appraised value and loan balance.
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Reference: IRS Publication 551 — Basis of Assets. Internal Revenue Service.