The tax-recognized investment in a property — gain measured against it.
Cost basis is the tax-recognized investment in a property — used by the IRS to calculate capital gain at sale and to determine the depreciable basis during the hold period. Initial cost basis is the purchase price plus closing costs and certain acquisition expenses. Adjusted basis reflects capital improvements added and depreciation deducted over time.
Cost basis matters at three points in a property's life. At acquisition, basis determines the depreciable amount. During the hold period, capex either gets added to basis (capital improvements) or expensed (repairs and maintenance) — and the distinction has major tax implications. At sale, basis determines the capital gain: sale price minus adjusted basis equals taxable gain.
The key distinction during ownership: capital improvements vs. repairs. Capital improvements (new roof, addition, HVAC replacement, structural work) get added to basis and depreciated over their useful life. Repairs and maintenance (paint, broken window, minor plumbing fix) are expensed immediately and reduce current-year taxable income but don't affect basis. Sophisticated investors classify expenditures correctly to optimize the tax timing.
Depreciation reduces basis dollar-for-dollar. A $400k cost basis with $80k of accumulated depreciation has an adjusted basis of $320k. At sale, that $80k of depreciation is "recaptured" — taxed at a 25% federal rate, even if held long-term. The 1031 exchange defers both gain and recapture; outright sale triggers both.
Sophisticated tax planning uses cost segregation to accelerate depreciation and 1031 exchanges to defer the recapture and gain at sale. A property held 10 years with $200k of depreciation taken has $40k of recapture tax + capital gains tax due at outright sale — or zero immediate tax if rolled via 1031. The math drives most sophisticated portfolio strategies.
| Original purchase price | $485,000 |
| + Closing costs at acquisition | $15,000 |
| + Capital improvements (year 3 roof + year 5 HVAC) | $32,000 |
| Total invested basis | $532,000 |
| – Accumulated depreciation (year 10 sale) | ($141,500) |
| Adjusted basis at sale | $390,500 |
| Sale price | $795,000 |
| Selling costs | ($55,650) |
| Net sale proceeds | $739,350 |
| Capital gain ($739,350 – $390,500) | $348,850 |
| Of which depreciation recapture | $141,500 |
| Of which long-term capital gain | $207,350 |
The tax-recognized investment in a property. Used by the IRS to calculate gain at sale and depreciable amount during ownership. Initial basis = purchase price + closing costs.
Original basis is the purchase price plus closing costs. Adjusted basis adds capital improvements made over time and subtracts accumulated depreciation taken. Adjusted basis is what determines gain at sale.
Capital improvements (new roof, addition, structural work) extend useful life and get added to basis. Repairs (paint, broken window) maintain current condition and are expensed immediately. The distinction has major tax timing implications.
Depreciation reduces basis dollar-for-dollar. A property with $50k of accumulated depreciation has $50k less basis at sale — increasing the taxable gain (with the depreciation portion recaptured at 25% federal).
When property is inherited, the basis is "stepped up" to fair market value as of the decedent's death — wiping out accumulated capital gains and depreciation recapture. Major estate planning advantage of holding real estate to death.
Matrix structures rental and bridge loans that work with your basis, depreciation, and 1031 strategy. Capital that fits your tax plan.
