Adjusted Basis

In the context of 1031 exchanges, the adjusted basis is a key concept used to determine the capital gains or losses when a property is sold or exchanged. It starts with the original purchase price (the initial basis) of the property and then adjusts for various factors over time.

Adjusted Basis = Original Purchase Price (Initial Basis) + Capital Improvements – Depreciation – Other Adjustments

1. Original Purchase Price (Initial Basis): This is the amount you paid to acquire the property, including the purchase price and certain other costs, such as closing fees.
2. Capital Improvements: These are expenses that add value to the property, prolong its useful life, or adapt it to new uses. Examples include building an addition or major renovations. These improvements increase the adjusted basis.
3. Depreciation: Over time, the IRS allows property owners to deduct a portion of the property’s value from their taxes, reflecting wear and tear or obsolescence. Depreciation decreases the adjusted basis.
4. Other Adjustments: These might include expenses like casualty losses (from fires, storms, or other natural disasters) or legal fees related to defending or perfecting title.

The adjusted basis is crucial in calculating the capital gain or loss when the property is sold or exchanged. For example, in a 1031 exchange, the adjusted basis of the old property is carried over to the new property, helping to determine future tax liabilities when the new property is eventually sold.