Real Estate Tax Calc
What adjusted basis is
Your adjusted basis is what you have 'invested' in the property for tax purposes. Start with your purchase price, add transaction costs (title fees, legal, recording fees), add the cost of capital improvements, then subtract all depreciation you have claimed over the years. Adjusted basis decreases every year you take depreciation — a $300,000 building depreciating at $10,909/year has an adjusted basis of $190,909 after 10 years.
Why lower basis means a bigger gain
Taxable gain equals sale price minus adjusted basis. If your basis has dropped by $110,000 over 10 years of depreciation, your gain on sale is $110,000 higher than it would be if you had never depreciated. That extra $110,000 of gain is exactly the recapture amount — it is the tax math working in reverse. Depreciation saves you money each year and costs you at sale; basis is the bridge between those two events.
The 'allowed or allowable' trap
The IRS reduces your basis by depreciation 'allowed or allowable' — meaning what you could have deducted, whether or not you actually claimed it. If you skipped depreciation for several years thinking you would avoid recapture, the IRS still reduces your basis and taxes you on the missed deductions at sale. This is why qualified advisors universally recommend claiming every depreciation dollar you are entitled to: you will owe the recapture either way, so you might as well take the deductions.
Building your starting basis: what goes in
Your original cost basis is more than the sticker price. Start with the purchase price, then add the acquisition costs a buyer normally pays that are not financing charges: title search and owner's title insurance, transfer and recording taxes, survey fees, legal and settlement charges, and any assumed back taxes. These become part of basis and are recovered through depreciation over time.
Costs of getting the loan are treated differently. Loan origination points, the lender's appraisal, credit report fees, and mortgage recording charges are financing costs — they are amortized over the life of the loan, not added to the property's depreciable basis. Mixing loan costs into basis is a common error that quietly overstates depreciation for decades.
Splitting basis between land and building
Only the building depreciates — land never does, because it does not wear out. So before you can depreciate anything, you must allocate your total basis between land and improvements. The most defensible method for most owners is the county assessor's ratio: if the tax assessment shows land at $60,000 and building at $240,000 (20% land / 80% building), apply that same 80% to your actual cost.
On a $330,000 purchase, an 80% building allocation gives a depreciable basis of about $264,000 and a land basis of $66,000. A higher building allocation means larger annual deductions, so the split is worth getting right and documenting. An appraisal that separately values land and improvements is stronger support than the assessor ratio if the two diverge materially.
Improvements raise basis; repairs do not
Not every dollar you spend on the property touches basis. Capital improvements — a new roof, an addition, a full kitchen remodel, a replaced HVAC system — are added to basis and depreciated (each improvement on its own schedule from the date placed in service). Repairs that merely keep the property in working order — patching, repainting, fixing a leak — are deducted currently on Schedule E and do not change basis.
The distinction matters at sale as much as during ownership. A $40,000 roof added in year six lifts your basis by $40,000, which reduces the eventual gain — but its own accumulated depreciation is recaptured alongside the building's. Keep every improvement as a dated line item in your records; reconstructing them years later from memory rarely holds up.
A full example from purchase to sale
Put the pieces together. You buy a rental for $330,000, pay $6,000 in title, legal, and recording costs, and allocate 80% to the building — a depreciable basis of about $268,800 and land of $67,200. Straight-line over 27.5 years is roughly $9,775 a year. You add a $40,000 roof in year six and claim depreciation on the whole schedule for ten years.
After ten years you have claimed roughly $97,750 on the building plus about $6,000 on the roof — call it $103,750 of total depreciation. Your adjusted basis is original cost ($336,000) plus the $40,000 roof, minus $103,750 of depreciation, or about $272,250. Sell for $460,000 net of costs and your gain is roughly $187,750 — of which about $103,750 is unrecaptured Section 1250 gain taxed at up to 25%, and the rest is long-term capital gain. Every number traces back to how you built and adjusted basis.
Basis in gifts, inheritance, and 1031 exchanges
Basis does not always start with a purchase. If you receive a rental as a gift, you generally take the donor's adjusted basis (a 'carryover' basis) and their remaining depreciation schedule — the built-in gain and future recapture come with it. If you inherit a rental, its basis is generally stepped up (or down) to fair market value at the date of death, which wipes out the decedent's accumulated depreciation and starts a fresh 27.5-year schedule for you on the building's stepped-up value.
In a 1031 like-kind exchange, the replacement property carries a substituted (deferred) basis — roughly the adjusted basis of the property you gave up, adjusted for any additional cash paid or boot received. The deferred gain and the old depreciation ride into the new property, so basis is how the tax you deferred stays tracked until a future taxable sale.
Common basis mistakes that cost money
Three errors recur. First, depreciating land — including the land allocation in your depreciable basis overstates deductions and creates an error the IRS can adjust for open years. Second, losing the paper trail — without records of your cost, allocation, and improvements, you cannot prove basis at sale and the burden falls on you. Third, forgetting to add improvements — owners who deduct a big remodel as a repair not only risk that deduction on audit but also understate basis and overpay tax at sale.
A subtler mistake is treating insurance reimbursements or casualty losses as irrelevant to basis. A casualty loss deduction reduces basis; an insurance payout you do not fully reinvest can too. Keeping a running basis worksheet from year one — cost, allocation, improvements, depreciation, and any adjustments — is the single best defense against surprises.
Two kinds of recapture at sale
When you finally sell, the depreciation you took does not all come back the same way. Straight-line depreciation on the building shell is 'unrecaptured Section 1250 gain,' taxed at your ordinary rate but capped at a maximum of 25%. If you ran a cost segregation study and reclassified components into 5-, 7-, or 15-year property, those are Section 1245 assets, and their depreciation is recaptured as ordinary income with no 25% cap.
Both are reported on Form 4797, and the capital-gain portion of your total gain flows to Schedule D. Understanding which bucket your depreciation falls into is part of understanding basis: cost segregation front-loads deductions but shifts some future recapture from the 25%-capped 1250 category into fully ordinary 1245 recapture. Basis records that separate the building from its reclassified components are what let you compute each correctly.
Planning tips built around basis
Because basis is the hinge between annual savings and the bill at sale, a few habits pay off. Maximize your building allocation (within defensible limits) to increase annual depreciation. Document every improvement so it lifts basis and reduces gain. And plan your exit around basis: a 1031 exchange carries your low basis and deferred gain into the next property, while holding until death gives heirs a stepped-up basis that can erase the built-in gain and recapture entirely.
The through-line is that depreciation is not free money — it is a rate-arbitrage and timing benefit. You deduct at your ordinary rate now and settle later at capped or deferred rates, and basis is the ledger that tracks the deal. Treat your basis worksheet as one of the most important records you keep on the property.
Refinancing and borrowing do not change basis
A common misconception is that pulling cash out of a property, or the size of your mortgage, somehow affects basis. It does not. Basis tracks what you invested and improved, not how you financed it. A cash-out refinance puts money in your pocket tax-free (it is a loan, not income) but leaves your adjusted basis, your depreciation schedule, and your eventual recapture exactly where they were. Two owners of identical buildings — one who paid cash, one who refinanced to 80% — have the same basis and owe the same recapture at sale.
The practical trap is that a large mortgage can exceed your adjusted basis after years of depreciation and loan proceeds. If you then sell, the gain (and the tax on it) can be larger than the cash you actually walk away with after paying off the loan — the dreaded situation of owing tax with little cash to show for it. This is a financing-and-basis mismatch, not a basis adjustment: the debt never lowered basis, so the recapture was always there waiting.
Casualty losses, insurance, and partial dispositions
Several mid-ownership events adjust basis and therefore the final recapture. A deductible casualty loss (from a federally declared disaster, under current law) reduces basis by the loss claimed; an insurance reimbursement you do not fully reinvest in repairs can also reduce basis. Conversely, money you spend rebuilding is a capital improvement that adds back to basis on its own schedule.
A partial disposition election is the cleanest way to keep basis honest when you replace a major component. If you tear out the original $18,000 roof and install a new one, electing a partial disposition lets you write off the old roof's remaining basis as a loss now — and removes that component's depreciation from the pool that would otherwise be recaptured at sale. Without the election, you keep depreciating a roof that no longer exists while also depreciating its replacement, overstating basis reductions and muddying the recapture math. If you discover years of missed or incorrect depreciation, Form 3115 lets you make a Section 481(a) catch-up adjustment in the current year rather than amending each old return — a tax professional should prepare it.
Frequently asked questions
Why does depreciation increase my gain when I sell?
Depreciation reduces your adjusted basis, which increases the taxable gain at sale. The portion equal to depreciation claimed is recaptured at up to 25%. The annual savings typically outweigh this cost.
Does refinancing or a cash-out loan change my basis?
No. Basis tracks what you invested and improved, not how you financed it. A cash-out refinance is tax-free loan proceeds and leaves your adjusted basis and depreciation schedule unchanged — though a mortgage larger than your remaining basis can mean owing tax on a sale that exceeds the cash you net after paying off the loan.
How does replacing a major component affect basis?
If you make a partial disposition election when you replace something like a roof, you write off the old component's remaining basis as a loss now and remove its depreciation from the future recapture pool. Without the election you keep depreciating a component that no longer exists while also depreciating its replacement, distorting both basis and the final recapture figure.
What if I never claimed depreciation — do I still owe recapture?
Yes. The IRS taxes recapture on depreciation allowed or allowable, so you owe it on what you could have taken even if you didn't. You gave up the deduction but kept the recapture liability.
How do I split my basis between land and building?
Most owners use the county assessor's land-to-building ratio applied to their actual cost, or a professional appraisal that values each separately. Only the building portion is depreciable; land never is.
Do closing costs increase my basis?
Acquisition costs like title insurance, transfer taxes, recording, legal, and survey fees are added to basis. Loan costs — points, lender appraisal, origination fees — are amortized over the loan term instead, not added to basis.
What happens to my basis when I inherit a rental property?
It is generally stepped up (or down) to fair market value at the date of death, which resets accumulated depreciation and starts a fresh depreciation schedule for you on the building's value.
Can I fix years of missed depreciation?
Yes. Rather than amending each old return, you generally file Form 3115 to claim a catch-up (Section 481(a) adjustment) for depreciation you were entitled to but did not take. A tax professional should prepare it.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.