One term you’re likely to hear during tax season is adjusted basis. What is adjusted basis? First, let’s define basis. Your basis in property is the starting point for deciding whether you have a gain or loss when you make a sale.
Generally, the basis starts as what you pay for the property (there are a separate set of guidelines that apply to assets you inherited or received as a gift; see IRS Publication 551, Basis of Assets, for more information).
The IRS defines basis as the amount of your capital investment in a property for tax purposes. The basis of stocks or bonds is the purchase price plus additional costs such as commissions and recording or transfer fees.
During the time that you own a property, the basis can be adjusted. For example, when you purchase rental property, the basis starts at what you pay for the property, including certain expenses resulting from the sale. The basis will be adjusted upward, according to the cost of permanent improvements. The basis is reduced by the amount of any depreciation you are allowed to deduct while you own the property. Adjusted basis is used to calculate the gain or loss on the sale.