A growing number of immigrants and foreign investors are buying real property in the United States 🇺🇸, raising important questions about how to calculate the cost basis and fair market value of these assets. Understanding these rules is critical for anyone buying, selling, or inheriting property, as it directly affects taxes and long-term financial planning.
The cost basis of real property is the starting point for figuring out how much tax you might owe when you sell a home or building. The cost basis is not just the price you paid for the property. It also includes certain fees and expenses you paid when you bought the property. If you buy both land and buildings together, you must split the cost basis between the land and the buildings. This split is based on the fair market value (FMV) of each part at the time you bought them.
For example, if you buy a house and the land it sits on for $500,000, and the land is worth $200,000 while the building is worth $300,000, you must divide the cost basis using these values. The cost basis for the land would be $200,000, and for the building, it would be $300,000. This is important because you can only claim depreciation on the building, not the land. Depreciation is a tax deduction that lets you recover the cost of the building over time, but land does not lose value in the same way, so it cannot be depreciated.
When you buy real property, you often pay more than just the purchase price. Some of these extra costs can be added to your cost basis. These include:
- Abstract fees (fees for checking the property’s title history)
- Charges for installing utility services
- Legal fees (for title searches, preparing the sales contract, and the deed)
- Recording fees (for officially recording the sale)
- Survey fees (for checking the property’s boundaries)
- Transfer taxes
- Owner’s title insurance
- Amounts you agree to pay for the seller, such as back taxes, interest, or repairs
Adding these costs to your cost basis can lower the taxes you owe when you sell the property, because your gain will be smaller.
However, not every cost you pay when buying property can be added to your cost basis. Some costs must be left out, such as:
- Casualty insurance premiums
- Rent for living in the property before closing
- Charges for utilities or services before closing
- Loan-related costs like points, mortgage insurance premiums, loan assumption fees, and appraisal fees required by a lender
- Fees for refinancing a mortgage, getting a second mortgage, or a home equity loan
- Amounts placed in escrow for future payment of taxes and insurance
Points are a special kind of fee paid to get a home mortgage. Points are prepaid interest and may be deductible as home mortgage interest, but they do not increase your cost basis. If you pay points to buy your main home and meet certain requirements, you may be able to deduct the full amount in the year you pay them. If you pay points to refinance, you usually have to deduct them over the life of the new loan. Points paid by the seller are a selling expense and reduce the seller’s gain, but if the buyer pays them, the buyer must subtract the amount from the cost basis of the home.
According to analysis by VisaVerge.com, many new immigrants and foreign buyers are surprised by how these rules work. For example, one recent buyer from Canada 🇨🇦 shared, “I thought all my closing costs would count toward my cost basis, but my accountant explained that only some fees actually qualify. It made a big difference in my tax planning.”
If you buy a property and take over an existing mortgage, your cost basis includes both the amount you pay for the property and the amount you still owe on the mortgage. This means your cost basis is the total amount you are responsible for, not just the cash you paid up front.
Let’s look at a practical example. Suppose you buy a house for $400,000 and take over a $100,000 mortgage. You also pay $5,000 in legal fees, $2,000 in recording fees, and $3,000 in survey fees. Your cost basis would be:
- Purchase price: $400,000
- Mortgage assumed: $100,000
- Legal fees: $5,000
- Recording fees: $2,000
- Survey fees: $3,000
Total cost basis: $510,000
If you later spend $50,000 to add a new room to the house, you can add this amount to your cost basis, making it $560,000. But if you pay $2,000 in insurance premiums or $1,500 in loan points, these do not increase your cost basis.
When you sell the property, your gain or loss is the difference between the sale price and your adjusted cost basis. If you sell for $600,000 and your cost basis is $560,000, your gain is $40,000. This is the amount you may have to pay tax on, depending on other factors.
It is important to keep good records of all your costs and improvements. The IRS may ask for proof if you claim a higher cost basis. Keep receipts, contracts, and statements for all qualifying expenses.
For immigrants and foreign investors, understanding the fair market value is also important. The fair market value is the price the property would sell for on the open market. When you buy a property, you use the FMV to split the cost basis between land and buildings. If you inherit property or receive it as a gift, the FMV at the time you receive it is often used as your starting cost basis.
If you make improvements to the property, like adding a new roof or remodeling the kitchen, you can add these costs to your cost basis. But repairs that just keep the property in good condition, like fixing a leaky faucet, do not increase your cost basis.
Depreciation is another key concept for property owners. If you use your property for business or rent it out, you can claim depreciation on the building (but not the land). Depreciation reduces your cost basis over time, which can increase your taxable gain when you sell. For example, if you claim $10,000 in depreciation, your adjusted cost basis goes down by $10,000.
Tax experts stress the importance of knowing which costs count toward your cost basis and which do not. As one tax advisor explained, “Mistakes in calculating cost basis can lead to paying too much tax or facing penalties. It’s always best to check the latest IRS rules or talk to a professional.”
Currently, there have been no major changes to the rules for cost basis or fair market value of real property. However, tax laws can change, so it is wise to check the latest IRS publications, such as Publication 551, or speak with a tax professional.
For immigrants and foreign buyers, these rules can seem complex, but understanding them helps avoid costly mistakes. Keeping detailed records, knowing which costs count, and getting advice from experts are the best ways to manage real property investments.
In summary, the cost basis of real property is more than just the purchase price. It includes certain fees and expenses, must be split between land and buildings based on fair market value, and is adjusted for improvements and depreciation. Not all costs can be added, so careful record-keeping and regular review of IRS rules are essential. For more information, visit the IRS official website or consult with a trusted tax advisor. This approach helps immigrants and all property owners make smart decisions and avoid surprises when it’s time to sell.
Learn Today
Cost basis → The total value including purchase price and allowable fees used to determine property tax owed when selling.
Fair market value → The price a property would sell for under normal market conditions at a given time.
Depreciation → A tax deduction that spreads the cost of a building over time but excludes land value.
Points → Prepaid mortgage interest often deductible but not included in the property’s cost basis calculation.
Transfer taxes → Taxes imposed during property transfer, which can be added to the cost basis of real estate.
This Article in a Nutshell
Understanding cost basis and fair market value is essential for immigrants and investors buying US real property. Properly accounting for fees, mortgage assumptions, and depreciation ensures accurate tax planning and avoids costly mistakes. Detailed records and professional advice help navigate complex IRS rules affecting property taxes.
— By VisaVerge.com
