A house is more than a home: It is an investment. Chances are good that the value of the home will change from the time you purchase it to the time you sell it. California’s foreclosure crisis aside, most of us believe that the value will go up so we can make a profit. When you sell a capital asset like a house, you realize a capital gain or a capital loss.
The IRS defines a capital gain as “the excess of the amount realized over the adjusted basis of the property.” If that doesn’t make sense, don’t worry. Just remember that the tax code does not like absolute numbers; it prefers to factor in other expenses and offsets that would reduce or increase the final dollar amount.
The amount realized, then, is the sale price minus expenses related to the sale. Those expenses can include commissions, legal fees and the like.
The IRS defines the adjusted basis as the basis plus or minus any adjustments. The general rule is that the basis is the price you paid for the home, whether you purchased it or built it. If you inherited the home, the basis is the fair market value on the date you received the home; in some instances, the basis can be the adjusted basis of the previous owner.
Adjustments are what you have put into the house to increase the value or things that have happened to the house that decrease the value. An addition to the home or a garage built to replace one lost in a wildfire — these are adjustments that increase the value because they have a “useful life” of more than a year. They stay with the home and increase its value over time. Mowing the lawn is not an adjustment.
Adjustments that decrease the value are a little more complicated, so we will put that discussion off until our next post.
Source: Internal Revenue Service, “Publication 523: Selling Your Home“