How Real Estate Gains or Losses are Computed

The selling expenses comprise the largest costs of selling a house.

Any expense incurred to complete the sales transactions will reduce the selling price of the property. Therefore, if the taxpayer realizes a capital gain on the sale, the selling expenses reduce the corresponding gain. However, the selling expenses are not deductible against ordinary income.

A few examples of expenditures related to the sale include:

• real estate sales commissions,
• staging a home for a sale,
• points paid by the seller to the buyer’s lending institution,
• attorney and accountant fees,
• settlement charges,
• closing fees,
• appraisal fees,
• advertising,
• escrow fees,
• title examination,
• title insurance, certificate (Torrens) and registration,
• document preparation,
• recording fees,
• transfer tax stamps,
• survey, and
• pest inspection.

What items cannot be included as selling expenses?

Buyers will pay for prorated items such as taxes, insurance, interest, rent, and finance charges. Remember, a taxpayer cannot count these items as selling expenses. Moreover, items not included are any expenses that physically affect the property (e.g., repairs or improvements), even if they are to prepare the property for sale.

Depreciable Property

The depreciation expense against rental income is the building value divided by 27.5 years of useful life.

Depreciation recognizes the decrease in value caused by wear and tear, outdated interior improvements, and neighborhood problems. To allow the depreciation tax deduction, the following three property conditions must be met:

• The depreciable property needs a capital expenditure (that is, not inventory, land, etc.).
• A trade or business produces income at the location.
• The property has a definite useful life of more than one year.

Once property qualifies for the depreciation expense deduction, the cost or other basis of the property will be decreased for depreciation at the end of each taxable year, whether or not the taxpayer has used the depreciation.

As a relief provision for taxpayers, the IRS permits a taxpayer to claim the allowable depreciation not taken into account previously.

Adjusted Basis

The adjusted basis is the original cost of the property plus the value of the improvements less depreciation and any losses taken during ownership.

For instance, common purchase price expenses added to the basis include the following:

• Attorney fees
• Escrow fees
• Recording costs
• Accountant’s fees
• Broker and finder fees
• Appraisal costs
• Surveys
• Inspection fees
• Title search and title insurance charges
• Costs of acquiring any outstanding leases
• Any expenses related to purchase other than those physically affecting the property

More specifically, the owner can improve the existing property, construct new property, or rebuild if property is damaged. In all cases, the improvement cost is added to basis and depreciated. However, sellers cannot deduct repairs on personal residences nor add repairs to the home’s basis.

To determine the difference between repairs and capital improvements, answer the following questions:

• Does the expenditure materially add to the property’s value?
• Does it prolong the property’s useful life?

If you answered yes to both questions, the cost is generally a capital expenditure.

Gain or Loss

When a property is sold or exchanged, the taxypayers will use the Gain or Loss Formula to calculate any gain or loss for taxes.