Start with original basis
Your starting point is the original cost basis, which for a purchased property is the purchase price plus acquisition costs — closing costs paid by the buyer (title insurance, attorney fees, recording fees, transfer taxes). Costs you paid at closing are typically added to basis rather than deducted as expenses.
If you inherited the property, your basis is the fair market value on the date of death (the step-up). If you converted a personal home to a rental, your basis is the lower of your adjusted cost basis or the fair market value at the conversion date.
Add improvements, subtract depreciation
Add capital improvements: any expenditure that adds value, extends useful life, or adapts the property to a new use increases your basis. New HVAC systems, roof replacements, additions, and appliances are improvements; routine repairs are not.
Subtract depreciation: every year of depreciation you claim (or could have claimed) reduces your adjusted basis. This is why selling after many years of depreciation can generate a large taxable gain even if the property's market value barely changed — the basis has been steadily eroded by the annual deductions.
The formula: Adjusted Basis = Original Basis + Capital Improvements − Accumulated Depreciation (allowed or allowable)
A worked example
Purchased: $350,000. Closing costs added to basis: $5,500. Total original basis: $355,500. Land value (not depreciable): $60,000. Building basis: $295,500. Improvements over 10 years: $30,000 new roof + $12,000 HVAC = $42,000. Accumulated depreciation over 10 years: $295,500 ÷ 27.5 × 10 = $107,454. Adjusted basis = $355,500 + $42,000 − $107,454 = $290,046. Sell at $550,000, selling costs $30,000, amount realized $520,000. Taxable gain = $520,000 − $290,046 = $229,954.
Frequently asked questions
What is adjusted basis on a rental property?
Adjusted basis equals your original purchase price (plus closing costs) plus capital improvements, minus all depreciation you claimed or could have claimed. It's the number subtracted from the amount realized to compute your taxable gain.
Do repairs increase my basis?
No. Routine repairs maintain the property but do not add to basis. Only capital improvements that add value, extend useful life, or adapt the property increase basis.
What if I forgot to take depreciation?
The IRS still reduces your basis for depreciation 'allowed or allowable,' even if you didn't claim it — and you still owe recapture. File Form 3115 to claim the catch-up deduction rather than losing it.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.