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How Do You Calculate Cost Basis and Depreciation on Schedule E Taxes?

how to calculate cost basis

If you own a piece of real estate, from which you derive an income, you can claim special deductions on a 1099 schedule E tax form. Accurately determining your property cost basis is an essential part of preparing your 1099 for the IRS. So, how do you calculate cost basis and depreciation for your property’s income?

If you calculate the cost basis by adding the cost of improvements to the property’s purchase price, you might be missing a step. In this article, learn what you need to know to correctly determine your cost basis and depreciation on your property income tax. And, discover how your business might be missing depreciable assets that are right under your nose.  

1099 E: How Do You Calculate Cost Basis and Real Estate Depreciation?

Ask most accountants the question, “How do you calculate the cost basis on real estate?” Many accountants’ answer is “add the cost of improvements to the purchase price.” Using this simple equation, however, is misleading when preparing your Schedule-E tax form. It omits one crucial factor – land is not depreciable.

If you calculate your depreciation and cost basis – by adding the property’s purchase price to the total cost of improvements – the IRS will not accept the deduction. In short, this common mistake leads your schedule E withholdings to include the cost of the land. Since land does not depreciate, you have to find the land value before you can determine a property’s true cost basis and depreciation.

How to Determine the Land Value of Your Purchased Property

The first step in determining your property’s cost basis is to find the value of the land. Accessing the properties tax card is the easiest way to find the value of the land on which your purchased property is sitting. The property tax assessment for your purchased property is available by requesting it through the county assessor’s office.

The tax card specifies the purchased properties “land ratio,” which allows you to accurately determine the value of the land. Apply the land ratio to the total purchase price to find the land’s true value. This allows you to separate the value of the land, which does not depreciate, from the property value, which does depreciate. 

How to Find the Cost Basis and Depreciation Basis: What Does it Include?

The cost basis for depreciation on your purchased property includes calculating several expenses associated with a purchased property. Calculating the fees and expenses that make up the cost basis can get complicated. Therefore, consult a tax advisor to ensure that you are including everything you can in your calculation. 

In addition, to the base purchase price, other expenses are added to determine the cost basis. Include closing costs, like transfer taxes, inspection fees, appraisal fees, and title insurance. And, you can also include the cost of travel, bank transfers, attorney compensation, and notary fees. 

So, the total of all expenses associated with the purchased property is your property cost basis. 

Use the Cost Basis to Find the Depreciable Basis

To deduct the depreciation from your property income tax, first, you have to find the depreciable basis. And, at this point, you know the purchase price, closing costs, and land value. From here, it is easy to find the depreciable basis.

The depreciable basis of your property is the closing costs and purchase price, minus the determined land value. The timeline of depreciation on residential property is 27.5 years, and 39 years on commercial property. The most common method of depreciation is the Modified Accelerated Cost Recovery System (MACRS). 

When your property is first put into service, the MACRS method grants a bonus half-months worth of depreciation. Divide your depreciable basis by 12, for each month in the year to find your monthly depreciation. Divide your monthly depreciation in half to find your MACRS bonus.

Loans and amortization, also factor into the total deductible expense. In the next post, learn about how these expenses factor into your 1099 schedule E tax form preparation. Or, contact a tax advisor today, for immediate help with your 1099-E and other tax preparations.

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