Property owners know the importance of cost basis when it comes to taxes. This is why it's important to know how to calculate the cost basis for raw land.
It is also a good idea to get a property appraised if a joint owner has recently died. However, there are many other instances where knowing the cost basis of a property, including raw land, helps determine the amount of taxes you have to pay and if a capital gains tax is owed on the property.
So how do you calculate cost basis for raw land? Cost basis is the purchase price of the raw land. To find that tally up all the depreciation and subtract it from the total cost.
Since knowing the cost basis for raw land or any property is so important and plays a major part in the taxes that you'll have to pay on the property, it pays to know how you can calculate the cost basis for any raw land that you may have bought.
As real estate experts who have been operating for years in the industry, we can help guide you through the process of finding the cost basis of the raw land you’ve purchased.
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Cost Basis of Raw Land
Knowing your property's "cost basis" is crucial for tax purposes, but demonstrating the cost basis may be challenging. Because the cost basis adjusts upon death, it's a good idea to have the property appraised when a joint owner passes away.
For tax purposes, the cost basis is the monetary worth of an item. The basis is used to evaluate whether an asset has gained or decreased in value to evaluate if a capital gains tax is payable. The cost basis, for example, is $100,000 if you buy land for $100,000.
Improvements to the property might raise the cost base. If no modifications are made, and the house is later sold for $200,000, you will be responsible for paying taxes on the $100,000 increase in value.
The cost basis of a property is "stepped up" when the owner dies. This signifies that the property's current value is used as the starting point. The property owner bears the duty of proving cost basis, which isn't always straightforward to accomplish, especially if the property was acquired or renovations were completed some time ago.
This is the reason why landowners need to preserve detailed records of any modifications, including receipts and purchase orders. If a joint owner dies, the property should be assessed to indicate the value at the moment it is "stepped up" in basis. Make a copy of the documentation so you may refer to it later.
Your cost basis is the amount you paid for your land plus a portion of the closing charges. The IRS will not allow you to deduct the expense of obtaining a mortgage, as well as the cost of prepaid property taxes, insurance, or utility services. However, any title expenses, escrow fees, closing fees, transfer taxes, or legal fees might be included in your base. Items you pay the vendor, such as their commission, are also factored into your cost base.
Calculating Cost Basis
At its most basic level, the cost basis of an investment is the entire amount originally invested plus any commissions or fees associated with the transaction. This can be expressed in terms of the investment's monetary value or the per-share price you paid for your investment.
It's critical to use the right cost basis, also known as the tax basis, especially if you ended up reinvesting your dividends as well as your capital gains distributions as opposed to cashing them out. Reinvesting dividends raises your investment's tax base, which you must account for in order to report a lesser capital gain and pay less tax. If you don't use the larger tax base, you might wind up paying taxes twice on the reinvested dividends.
Calculating profits and losses once a stock is sold begins with determining the right cost basis. Investors frequently utilize the average cost basis technique for mutual fund tax filing. Your assets are reported using a cost basis technique with the brokerage business where they are kept. Many brokerage companies use the average cost basis approach by default.
Other options available to investors include first-in-first-out (FIFO), last-in-first-out (LIFO), high cost, low cost, and others. Once a cost basis technique is established for a mutual fund, it must be followed. Investors will get relevant yearly tax paperwork on mutual fund transactions depending on their cost basis method elections from brokerage providers.
The notion of cost basis is simple in theory, but it may be complex in a variety of ways. Cost basis tracking is necessary not just for tax considerations but also to track and judge investment performance. The goal is to keep meticulous records and to keep your investment approach as simple as possible.
If the property were given to you as a gift, the original holder's (the person who gifted you the property) cost basis is your cost basis. The lower rate is the cost basis if the shares are trading at a lower price than when they were donated.
What’s Included in Cost Basis?
Aside from the purchase price, the modifications you make to the property are a significant part of the cost basis. These can be done just after the property is purchased or at a later time.
Improvements, according to the IRS, are costs that increase the value of a property, extend its useful life, or adapt it to new uses. There's clearly some ambiguity here. However, examples will assist in clarifying things. Plumbing, additions, and, of course, building are such examples.
While general repairs aren't included in the cost basis of a property, they can be included if they're done as part of a qualifying improvement project. Repairing minor holes in your walls, for example, isn't an improvement.
What’s Not Added to Cost Basis?
In general, if an expense doesn't add value to the property, lengthen its life, or change its functional purpose, it isn't added to your cost base (such as converting from a single-family home to a duplex or constructing on raw land).
In reality, this means you can't include the expenses of routine maintenance or repairs. You may claim that repairing plumbing leaks and other minor repairs increases the value of your home. However, these costs are required in order to keep the property in excellent functioning order.
Here's an example. If the motor in your refrigerator fails, you'll need to call a repairman to get it fixed so that you can use your house again. Purchasing a new refrigerator when you can repair the old one is an additional cost. This is a discretionary cost that adds value to the property. Additionally, you cannot include any enhancements with a life expectancy of less than one year in your cost base.
This may be useful advice, particularly when it comes to landscape enhancements. Adding palm trees to your yard, for example, may be a foundation-increasing upgrade. Annual flowers that need to be replaced the next year do not count. Finally, if improvements are no longer part of your property, you can't include them in your base.
About THE AUTHOR
Brittany has been in the land business since 2020 when the world was starting to shut down. Since then, we’ve sold to dozens of people from ATV weekend warriors to camping enthusiasts to retired truck drivers. Our inventory spans mostly in the western United States. We’ve been trained by experience, land acquisition courses, and hundreds of hours meeting with county assessors and clerks, zoning officials, realtors, and land investors. We’ve answered hundreds of questions from people regarding the buying and use of land.Read More About Brittany Melling