What Is Cost Basis in Real Estate and How Do You Prove It?

The short answer: the cost basis of real estate is what you paid for it, plus the closing costs you could not deduct, plus the cost of improvements, minus any depreciation you claimed or could have claimed. When you sell, the difference between the sale price and that adjusted basis is your taxable gain. Basis resets to fair market value when an owner dies, which is why inherited property is often sold with little tax, and it does not reset when property is given away during life. The burden of proving basis is on the owner, and families who cannot document it can end up paying tax on gain they never had.

This article explains what goes into the basis of real estate, how it changes at death, on a joint owner’s death, and by gift, and what to do when the receipts are gone. For a deeper look at what happens to basis at death, see our article on the step-up in basis for inherited property.

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What Is Cost Basis?

Basis is the number the tax law uses to measure gain or loss. For purchased property, it begins as cost. If you bought a house for 400,000 dollars and sell it for 650,000, your gain before adjustments is 250,000, and that is what you pay capital gains tax on. If you sell a house for less than its basis, you have a loss, which is deductible for investment property but not for a personal residence.

Basis matters at three moments: when you sell, when you die, and when you give property away. Getting it right at each one requires knowing what is included.

What Adds to the Basis of Real Estate?

Under Section 1016 of the Internal Revenue Code, basis is adjusted upward for “expenditures, receipts, losses, or other items, properly chargeable to capital account.” IRS Publication 551 translates that into a list.

Settlement costs you can add include abstract and title search fees, legal fees for the sales contract and deed, recording fees, surveys, transfer taxes, owner’s title insurance, and any of the seller’s costs you agreed to pay, such as back taxes or commissions. In New Jersey, the realty transfer fee a buyer pays on higher-priced homes and the seller’s fee, if the buyer absorbs it, are transfer taxes that go into basis.

Settlement costs you cannot add include anything connected with getting a loan: points, mortgage insurance, appraisal and credit report fees, and loan assumption fees. Casualty insurance premiums, prepaid utilities, and rent for occupying the property before closing are also excluded.

Improvements add to basis; repairs do not. IRS Publication 523 lists the kinds of improvements that count: additions such as a bedroom, bathroom, deck, garage, or patio; systems such as heating, central air, wiring, and security; exterior work such as a new roof, siding, or storm windows; and interior work such as built-in appliances, a kitchen remodel, or new flooring. Work that keeps the home in good condition without adding value or prolonging its life, such as painting and patching, is a repair and does not count. The line is not always clean. Replacing a roof is an improvement; patching it is a repair. Replacing all the windows is an improvement; replacing one broken pane is not.

What Reduces Basis?

Depreciation. If the property was ever rented or used in a business, basis is reduced by the depreciation “allowed or allowable,” in the words of Section 1016(a)(2). That phrase catches owners who rented out a house for years and never claimed depreciation. The law reduces their basis anyway, as if they had. Casualty loss deductions and certain energy credits also reduce basis.

For a rental property held for decades, depreciation can drive basis close to the land value alone, so the gain on sale, and the portion taxed as recaptured depreciation at 25 percent, is far larger than the owner expects.

What Happens to Basis When the Owner Dies?

Under Section 1014, property acquired from a decedent takes a basis equal to its fair market value on the date of death. The gain that built up during the owner’s life disappears for income tax purposes. A house bought for 90,000 dollars in 1985 and worth 700,000 at the owner’s death in 2026 passes to the children with a 700,000-dollar basis. If they sell it for 710,000, the taxable gain is 10,000. Section 1223(9) adds that property acquired from a decedent and sold within a year of death is treated as held for more than a year, so the gain is long-term no matter how quickly the heirs sell.

The executor may instead elect under Section 2032 to value the estate six months after death, but only if that election reduces both the gross estate and the estate tax due, which limits it to estates large enough to owe tax.

The step-up depends on the property being included in the decedent’s estate for tax purposes, and it is not available for property the decedent gave away during life or for most property in an irrevocable trust that was designed to remove it from the estate. Our step-up article covers those exceptions, including retirement accounts and community property.

What Happens When a Joint Owner Dies?

This is where the current version of most online guidance oversimplifies, and the answer depends on who the joint owners were.

Spouses. Under Section 2040(b), when property is held by spouses as joint tenants or tenants by the entirety and one dies, exactly one-half of the value is included in the deceased spouse’s estate, and that half receives a new basis. A couple who bought a home for 200,000 dollars and held it jointly until one spouse died when it was worth 600,000 leaves the survivor with a basis of 400,000: the survivor’s original 100,000 half plus the deceased spouse’s half stepped up to 300,000. The survivor’s own half keeps its original basis no matter who paid for the property.

Non-spouses. Under Section 2040(a), when a parent and child, or two siblings, hold property jointly with right of survivorship and one dies, the entire value is included in the decedent’s estate except the portion the survivor can show they paid for with their own money. A parent who adds a child to the deed of a house the parent bought, and then dies, is treated as owning the whole house at death, so the child receives a full step-up on the whole property. That is a good result for basis but often a bad one for other reasons: the transfer to the child was a gift when made, the house is exposed to the child’s creditors, and for Medicaid purposes it is a transfer subject to the look-back. If instead the child contributed half the purchase price and can prove it, only half is included and only half steps up. Records of who paid what are therefore essential for joint property between non-spouses.

What Happens to Basis on a Gift?

The opposite of death. Under the rules summarized in IRS Publication 551, a person who receives property as a gift takes the donor’s adjusted basis, increased in some cases by gift tax paid, so the built-in gain follows the property. If a parent bought a house for 90,000 dollars and deeds it to a child while alive, the child’s basis is 90,000, and a later sale for 700,000 produces a 610,000-dollar taxable gain that would have vanished had the child inherited the house instead. For property worth less than the donor’s basis at the time of the gift, a special rule uses the lower fair market value to compute any loss.

Whether to give a house during life or leave it at death is one of the most common questions in our practice, and basis is only one factor. Medicaid planning, estate tax in New York and Connecticut, control, and the child’s creditors all weigh in, and there are trust designs that remove a home from the countable estate for Medicaid while preserving the step-up. Our article on estate planning for a vacation home walks through those choices.

How Do You Prove Cost Basis?

The taxpayer bears the burden. The IRS does not have to prove your basis was low; you have to prove it was high, and an unsupported figure may be treated as zero. IRS Publication 551 puts it plainly: “You must keep accurate records of all items that affect the basis of property so you can make these computations.” Keep them for as long as you own the property and at least three years after the return reporting the sale.

The records that matter are:

• The closing statement from the purchase, which shows the price and every settlement cost
• The deed, which in New Jersey shows the realty transfer fee paid and lets you back into the purchase price if the closing statement is lost
• Contractor invoices, cancelled checks, and credit card statements for every improvement
• Building permits and certificates of occupancy, which establish that major work was done and when
• Depreciation schedules from every year the property was rented
• For inherited or jointly held property, the date-of-death appraisal, the estate tax return if one was filed, and evidence of each joint owner’s contributions

What If the Records Are Gone?

Reconstruct them before you sell, not after the IRS asks. Purchase price can be recovered from the county clerk’s deed records, which show transfer taxes and often the consideration, from old mortgage documents, and from the title company that closed the purchase. Improvements can be supported with permits from the municipal building department, before-and-after photographs, contractor records, and, for older work, a contemporaneous appraisal that describes the house as improved. Property tax assessments are not fair market value and do not establish basis, but they can corroborate when an addition first appeared.

For inherited property with no appraisal, a retrospective appraisal establishing value as of the date of death is routine and worth the fee. It is the single document that supports the stepped-up basis, and appraisers can prepare one years after the fact using comparable sales from that time.

Two State Rules Worth Knowing

The New Jersey exit payment. A seller who is not a New Jersey resident, including an estate or an heir living out of state, must pay an estimated gross income tax at closing of at least 2 percent of the sale price, using the GIT/REP forms, unless an exemption applies. The payment is credited against the actual tax on the gain when the seller files a New Jersey return, so a seller with a stepped-up basis and little gain gets most of it back, but only by filing. Heirs who have never lived in New Jersey are often surprised at the closing table.

The home sale exclusion. Section 121 lets a seller exclude up to 250,000 dollars of gain, or 500,000 for a married couple filing jointly, on a home they owned and used as a principal residence for two of the five years before sale. Heirs selling a parent’s house do not qualify, because they did not live there, which is why the step-up matters so much to them. A surviving spouse who sells within two years of the other spouse’s death can still use the 500,000-dollar figure.

Plan Well. Live Better.

Basis is the quietest number in an estate plan and one of the most expensive to get wrong. At Milvidskiy Law Group, we help clients decide how to hold and transfer real estate so that the next generation inherits the property, not the tax bill, and we help executors and heirs document the basis they are entitled to. Learn more about our estate planning services.

This article is for general informational purposes only and does not constitute legal or tax advice. Reading it does not create an attorney-client relationship. Basis rules depend on the specific facts, including how title was held, who paid for the property, and how it was used. Code sections and IRS guidance cited were verified in September 2026 and should be confirmed with a tax advisor before acting.