Cost Basis for Real Property

When dealing with real property, there are certain costs that add to the value of the property while others are considered period costs that are expensed when incurred. The distinction between the two types of property costs determines the basis for which gains or losses are calculated when sold. It also affects the value of the property when seeking financing using the property as collateral. First, let’s start with what costs can be included in the value of the property.

The costs that can be included in the basis of any real property start with items like: the purchase price, improvements and construction costs, certain closing costs, and in some cases, insurance and taxes. The improvements and construction costs include all materials and labor costs. This includes costs for architect designs and demolition of current features. All costs that are incurred to improve the current features of a property can be included in the basis. Closing costs such as recording fees, title fees, legal fees to prepare the purchase contracts, and surveys are all closing costs that can be included in the cost basis of a property. Title insurance is the one type of insurance that can be included in the basis. Other insurance like home owners or fire insurance needs to be expensed as incurred. Taxes, on the other hand, can only be included in certain situations. When the property is purchased with unpaid taxes, the taxes can be included in the cost basis. If the taxes are paid to the seller to reimburse for paid taxes, it needs to be expensed in the correct period.

There are certain costs that cannot be included in the basis for real property. These are the items that are incurred to obtain financing on the property. Interest, loan points, mortgage premiums, appraisals, and credit reporting costs are all examples of costs that cannot be included in the cost basis of real property. These costs are not necessary to obtain a property. If the property was paid for in cash, these costs would not be incurred and are, therefore, not a requirement of obtaining a property.

As a general rule, costs that are required to obtain or improve a property can be included in the cost basis. While costs that are not necessary because there are alternative methods of obtaining the property in which the cost would not have occurred, cannot be included in the basis. Insurance is the one exception to these generalizations. Usually insurance is required, but this is not a one-time cost, but rather a period cost that recurs every year that the property is owned.

Written by:
Ashley Peth
TGG Accounting
 
 
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