I. Cost Basis
First find the owners’ initial cost of real property by adding your purchase price and allowable closing expenses as follows:
COST BASIS = PURCHASE PRICE + ALLOWABLE CLOSING EXPENSES
II. Adjusted Basis
This is calculated later after owner adds capital improvements that add value and prolong property’s life. Adjusted Basis is also known as the Original Net Value.
ADJUSTED BASIS = COST BASIS + PHYSICAL CAPITAL IMPROVEMENTS – SALE OF EASEMENT – DEPRECIATION
No painting, no ordinary repairs and no maintenance costs like washing exterior, etc.
a) Calculating Depreciation
Depreciation is the loss in value for any reason of a real estate property. The easiest way to calculate depreciation is the straight line method of depreciation when it is taken in equal amounts over an asset’s useful life. For residential rental property the Economic Useful life is 27.5 years and for nonresidential it is set to 39 years.
%DEPRECIATION=CURRENT AGE / ECONOMIC USEFUL
DEPRECIATED AMOUNT = BLDG+IMPROVEMENTS x % DEPRECIATION
III. Amount Realized
When the owner sells the real estate property after subtracting allowable closing expenses. Amount Realized is also known as Present Net Value.
AMOUNT REALIZED = SALES PRICE – ALLOWABLE CLOSING EXPENSES
IV. Capital Gain/Loss
To find capital gains or losses you find the difference between your amount realized from the recent sale and your investment with the subsequent capital improvements.
CAPITAL GAIN/LOSS = AMOUNT REALIZED – ADJUSTED BASIS
V. Net Profit
NET PROFIT = AMOUNT REALIZED – ADJUSTED BASIS
% NET PROFIT = NET PROFIT / ADJUSTED BASIS
Another easier way to remember these formulas is to consider Amount Realized as being the NEW dollar amount and the Adjusted Basis being the ORIGINAL investment dollar amount and the easy to remember % NET PROFIT formula would be as follows: