Adjusted Basis: The Number That Decides Your Gain

How to calculate adjusted basis, line by line

Basis starts as cost (IRC 1012) and then moves every year you own the property (IRC 1016). For a building, a business asset or a rental, build it like a ledger:

IRS Publication 551 lists what belongs on the acquisition line and what does not: loan costs such as points, mortgage insurance, lender-required appraisals and credit reports are not basis, and neither are casualty insurance premiums or rent paid to occupy before closing. Amounts placed in escrow for future taxes are not basis either.

Depreciation: the line that surprises sellers

The single largest basis adjustment on most commercial and rental property is depreciation, and the rule is unforgiving. Basis is reduced by the depreciation allowed or allowable, whichever is greater (IRC 1016(a)(2); Treas. Reg. 1.1016-3). If you skipped depreciation for years, your basis still drops as if you had claimed it, and you get no deduction for those years unless you fix it.

The fix is usually a change in accounting method: when an impermissible method has been used for two or more years, IRS Publication 946 points to Form 3115, which can catch up the missed depreciation in one year before the sale. That turns a pure tax cost into a deduction that offsets part of the recapture. On a sale, the depreciation you took becomes unrecaptured 1250 gain on buildings, taxed at up to 25% (IRC 1(h)(1)(E), 2026), or ordinary 1245 recapture on equipment; see the depreciation recapture analysis.

What missing records cost: the Oregon example

A couple bought an Oregon rental for $500,000 and paid $12,000 of title, recording and transfer costs. Over the years they spent $140,000 on improvements and took $180,000 of depreciation. Adjusted basis: $472,000. They sell for $1,200,000 and pay $60,000 to sell, so the gain is $668,000 and the engine puts the tax at $209,769, including $66,132 to Oregon, which taxes gain as ordinary income with a top 9.9% bracket (Oregon Department of Revenue rate charts, 2026).

Now suppose the improvement invoices are gone and the depreciation schedule only covers the original building. The gain rises to $808,000 and the tax to $256,949: $47,180 more for the same house. The burden of proving basis sits with the taxpayer, so reconstructing records before closing (contractor statements, permits, bank and card statements, insurance appraisals, old Forms 4562) is some of the best-paid paperwork a seller ever does.

Inherited basis versus gifted basis

How you received property can matter more than anything you did with it. Property acquired from a decedent generally takes a basis equal to fair market value at death, or at the alternate valuation date if the executor elects it (IRC 1014(a)). When an estate tax return is required, your basis must be consistent with the value reported to you on Schedule A of Form 8971 (IRC 1014(f)). In community property states, both halves of community property get the new basis when the first spouse dies (IRC 1014(b)(6)).

A lifetime gift is different: the recipient keeps the donor's basis (IRC 1015(a)), increased by the part of any gift tax paid that relates to the appreciation (IRC 1015(d)(6)). For losses there is a dual-basis rule: if value at the gift was below the donor's basis, the lower value is used to measure a loss.

Our Illinois duplex shows the stakes. A parent paid $300,000 and the duplex was worth $950,000 at death. Inherited and sold for a net $1,140,000, the single heir's tax is $42,845. Had the parent given it during life, the same sale costs $232,206, or $189,361 more. One trap: if you give appreciated property to someone who dies within one year and it comes back to you, no step-up applies (IRC 1014(e)). See capital gains on inherited property and the step-up at death analysis.

Partnership and S corporation basis

If you sell an interest in an LLC taxed as a partnership or shares of an S corporation, the basis that matters is your outside basis in the interest, not the entity's basis in its assets.

• Partnership interest (IRC 705, 752). Start with cash and the basis of property contributed, add your share of income each year and your share of partnership liabilities, subtract distributions and your share of losses. When you sell, your share of liabilities is part of the amount realized (IRC 752(d)), so losing track of debt understates the gain. Part of the price tied to receivables and inventory is ordinary under IRC 751.
• S corporation stock (IRC 1367). Add income items, including tax-exempt income; subtract distributions, losses and nondeductible expenses. Loans you made to the company create separate debt basis. Shareholders claiming losses, receiving distributions, disposing of stock or getting a loan repayment must attach Form 7203 (IRS instructions, 2025 tax year).

Basis built from K-1s drifts quickly when nobody keeps the running total. For buyers who want assets rather than stock, see asset sale vs stock sale.

Records to gather before you list

1. Purchase settlement statement and deed, plus any 1031 exchange paperwork (Form 8824) that carried basis forward.
2. Every depreciation schedule since purchase, including cost segregation studies and bonus or Section 179 elections.
3. Improvement invoices and permits, sorted by year, with dispositions of replaced components noted.
4. Casualty claims and insurance settlements, and any easement or condemnation payments.
5. For inherited property: date-of-death appraisal and any Form 8971 Schedule A. For gifts: the donor's basis records and Form 709.
6. For entity interests: every K-1, capital account history, Form 7203 for S corporation shareholders, and partnership liability allocations.

Once basis is solid, the gain is solid, and the real choices open up: timing, a Section 453 installment sale, a 1031 exchange, or harvesting losses. To model those on your verified basis, get the Big Sale Tax Analysis.

Run your own numbers

Frequently asked questions