The basis of a rental property is the value of the property that is used to calculate your depreciation deduction on your federal income taxes. The Internal Revenue Service (IRS) defines the tax basis of a rental property as the lower of fair market value or the adjusted basis of the property. You can calculate the tax basis of a rental property by calculating the fair market value of the property and then comparing it to the adjusted basis of the property.
Determine the fair market value of the rental property. If the property was purchased as a rental property, the fair market value is the value of the property on the purchase date. If the property was converted from personal use to a rental property, fair market value is the value of the property on the date of conversion. As an example, assume the fair market value of a rental property is $200,000.
Determine the adjusted basis of the rental property. The adjusted basis is the cost of the building plus any permanent improvements or other capital costs minus the value of the land. Assume the rental property was purchased for $150,000 and had a land value of $25,000. Since purchasing the property, you have invested $30,000 into capital improvements. $150,000 + $30000 - $25,000 = $155,000.
Compare the fair market value figure from Step 1 by the adjusted basis of the property from Step 2. The lower of the two amounts is your tax basis for the rental property. Continuing the same example, since $155,000 is less than $200,000, your tax basis for the property is $155,000.