To figure the basis of property you receive as a gift, you must know 3 amounts:

If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or loss when you dispose of the property.

Note:  If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property.

If the FMV is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. If you received a gift after 1976, increase your basis by the part of the gift tax paid on it that is due to the net increase in value of the gift.  To figure the net increase in value or for more information on gifts received before 1977, see Publication 551, Basis of Assets. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property.

Basis is your investment in property for tax purposes. There are 2 major uses of basis:

Before figuring gain or loss on a sale, exchange or other disposition of property, or figuring allowable depreciation, depletion or amortization, you must usually make certain adjustments to the basis of the property.  The result of these adjustments to the basis is the adjusted basis.

Increases to basis include but are not limited to:

Decreases to basis include but are not limited to:

You may qualify to exclude from your income all or part of any gain from the sale of your main home if during the 5-year period ending on the date of the sale you meet the ownership and use tests described below and in Publication 523, Selling Your Home.

If you owned and lived in the property as your principal residence for less than 2 years, you may still be able to claim a reduced exclusion.  See Publication 523, Selling Your Home, for more information.

If you are required to report or choose to report a gain on the sale of your principal residence, use Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, and Schedule D (Form 1040) (PDF), Capital Gains and Losses.

Note:  If you (or your spouse) were on qualified official extended duty as a member of the U.S. uniformed services or U.S. Foreign Service, as an employee of the U.S. intelligence community, or as an employee or volunteer of the Peace Corps, you may elect to suspend the five-year test period for up to 10 years. You may use this provision for only one property at a time.  Qualified official extended duty is any extended duty while serving at a duty station at least 50 miles from the property or while residing under Government orders in Government quarters.  Extended duty is any period of active duty following a call or order to duty for a period of more than 90 days or for an indefinite period.

The money you receive from the sale of your home is part of your amount realized on the sale, even if the money is used to pay off the mortgage. However, the money may not be subject to tax.

If your amount realized, which generally includes any cash or other property you receive, plus any indebtedness assumed or paid off by the buyer, minus your selling expenses, exceeds your adjusted basis in your home, you have a capital gain on the sale.  

Your adjusted basis is generally your home’s cost plus any capital improvements (if you financed the purchase of the house by obtaining a mortgage, the mortgage proceeds are included in determining your cost basis in your residence). 

You may be able to exclude from income all or a portion of the gain on your home sale.  If you may exclude all of the gain, you do not need to report the sale on your tax return, unless you are required to otherwise file a return and you received a Form 1099-S (PDF), Proceeds From Real Estate Transactions.  To determine the amount of the gain you may exclude from income or for additional information on the tax rules that apply when you sell your home, refer to Publication 523, Selling Your Home.  Any gain that you may not exclude must be reported as income on your return.

As long as you satisfy the ownership and use tests and have not excluded gain from the sale of a principal residence within the two- year period ending on the date of the sale, you can exclude gain from the future sale of your principal residence within the limits of the exclusion.  As long as you meet the requirements of the exclusion, the number of times you claim the exclusion is not limited.

You may be able to exclude gain from the sale of the property. The capital gain exclusion associated with the sale of the principal residences requires that you:

If you used and owned the property as your principal residence for 2 years out of the 5 year period ending on the date of sale, you have met the ownership and use tests for the exclusion. This is true even though the property was rental property for the last 3 years before the date of the sale.

For rental property, the law has additional limits on the amount you may exclude; you may not exclude the part of your gain equal to any depreciation deduction allowed or allowable for periods after May 6, 1997.

Generally, you are allowed an annual depreciation deduction on your rental property and must reduce the basis of the property by the amount of your depreciation deductions. If you do not claim some or all of the depreciation deductions allowable under the law, you must still reduce the basis of the property by the amount allowable before determining your gain on the sale of the property.  

The gain attributable to the depreciation may be subject to the 25% unrecaptured Section 1250 gain tax rate. Refer to Publication 523, Selling Your Home, and Form 4797 (PDF), Sales of Business Property, for specifics on how to calculate and report the amount of gain.

Your second home (such as a vacation home) is considered a personal capital asset. Use Schedule D (Form 1040) (PDF), Capital Gains and Losses, and Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, to report sales, exchanges, and other dispositions of capital assets.