What's cost basis of a house built overseas from scratch?

[Boomhauser]

Hello,

I'm new to this forum. I understand taxes, but this issue is not 100% clear to me. About 20 years ago I received a land (gift) from my parents overseas. Over the past 20 years I've been slowly building a one family house. It takes a while because I live in the US, also, my father helped me a lot. My question is, what's my cost basis? Is it the land cost which i received as a gift and then added construction cost or everything combined. I have majority of receipts, but I'm sure some are missing. Also, is the IRS going to approve handwritten receipts from contractors showing their work and charges. Some contractors in Europe were not required to provide receipts and we don't have capital gains tax per say. In my country after 5 years of owning property you're free to sell it even with profit and you don't pay any income taxes. Thanks a lot.

[MonikaK1]

To figure out the basis of property received as a gift, you must know three amounts:

• The donor's adjusted basis just before the donor made the gift.
• The fair market value (FMV) of the property at the time the donor made the gift.
• The amount of any gift tax paid on the gift (Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return), if applicable.

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

• Your adjusted basis for figuring a gain is the donor's adjusted basis just before the donor made the gift, increased or decreased by any required adjustments to basis while you held the property.
• Your adjusted basis for figuring a loss is the FMV of the property at the time the donor made the gift, increased or decreased by any required adjustments to basis while you held 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 of the property at the time the donor made the gift is equal to or greater than the donor's adjusted basis, your adjusted basis is the donor's adjusted basis just before the donor made the gift, increased or decreased by any required adjustments to basis while you held the property.

• If the donor paid a gift tax on the gift and made the gift after 1976, increase your basis by the gift tax paid on the net increase in value. To figure out the net increase in value or for other information on gifts received before 1977, see Publication 551, Basis of Assets.

See this IRS webpage for more information.

Your cost basis in the improvements to the property would be the cost, in USD, of materials and labor used in building the house. You would not include the value of your own labor. Keep records to the best of your ability. If costs are paid in cash, make a timely written record of the purchase or amount paid for labor. 

[Opus 17]

Your cost basis is the cost basis of the land, plus what you paid to build the house.  The cost basis of the land is probably what your parents originally paid for it, using the US$ conversion from local currency as of the date they bought the land.

Likewise, the prices you paid for materials and labor are added to the cost basis using the US$ value of the expenses on the date you paid them.  You can include costs paid by other people for you, because that all goes toward improving the property.  You can also include certain fees like the cost of mandatory permits and inspections.  (Side note, you can't include the cost of bribes, even if that is how things are done in that part of the world.). You can't include costs you didn't pay for, like the value of your own or your family's labor.  

If you are audited, the IRS does not have to award anything you can't prove with reliable records.  What is a reliable record? Certainly invoices and receipts. If you have good, thorough records of what you paid (like a spreadsheet with name, date, amount and purpose, for all your expenses), that would give the auditor confidence in your overall meticulous nature and record keeping, they can overlook one or two missing receipts.  If your records are sloppy and incomplete, or if it looks like you tried to add items from memory the night before the audit, they aren't required to believe you.  So be reasonably careful and thorough if you can.  

[Boomhauser]

Thank you both, and no, we don't have to bribe anyone in Europe to build a house, haha.

@Opus 17I have a few more questions.

1. So basically,  if the land I received as a gift was $10,000 and my expenses to build the house up to day of sale were S140,000, my basis is $150,00, right?

2. Do I have to provide any date? I know for rental properties for example a date of purchase is required. In my case what would be that date? I'm sure when you sell a property a purchase date would be required. Is it the date when my parents gifted me the land or the date when I finished building the house before the sale?

It's a 20 year difference.

3. I have more than hundred receipts issued over 20 year period, do I have to convert every receipt to USD using exchange rate for each particular day they were issued?

4. Let's say I don't have an official receipt for putting a roof and I know that an average price in 2010 was let's say $20,000, is the IRS going to approve a hand written receipt with that price for that work? To make thing worse the person who did the work can't be reached or died? I know it's extreme, but I might be missing some receipts for major work and I'd like to prepare myself for any potential situation.

5. Last question: If I don't have any receipts to prove my cost basis, because the receipts were lost or burned, how do I even prove my basis. The house is there and was built, so the IRS can't question that fact. Should I use the FMV for a similar property in that area or hire a professional estimator to estimate the cost of building such property?

Thank you,

[Opus 17]

@Boomhauser

1. Yes. 
2. You don’t need to report anything until you sell the property. When you sell the property, you will calculate capital gains by using the acquisition date, adjusted cost basis, selling date, and selling price. The acquisition date for real property is the date you acquired the land. The adjusted cost basis is the cost basis for the land plus all the cost that you put into improving the land.

3. I believe the treasury department provides an average conversion rate for each year somewhere on their website. You can use the average conversion rate for the year to convert all the receipts for that year.
4. That comes down to the question of what is a “reliable record.“ The IRS does not have to award any basis you can’t prove. I have never been audited, but it seems to me that a reasonable auditor would realize that you had to pay something for the roof, the question is how much did you pay?  Depending on how nitpicky they want to be, they could assume that you only paid for materials and got free labor, and use an average value for the cost of materials, or they might allow you to claim something for labor. You should write down as much as you can remember of what happened; such as the amount you paid, the name of the contractor, And so on, even if you don’t have an invoice from the contractor any longer. 
5. Fair market value is not an indication of cost basis.  If you bought the house, you could have paid below market value or above market value; you could’ve received the house as a gift with no cost basis; or you could’ve built the house all with your own labor, and your only cost basis is materials.   The problem is that multiple courts have ruled that the IRS does not have to award any adjustment to income that the taxpayer can’t prove. This is essentially settled law, and you aren’t going to get anywhere by saying (if audited) “the house existed so it must have cost something.“  It is your  burden of proof, not the IRS’.  

Most taxpayers are never audited, usually less than one percent. I can’t tell you how likely you are to get audited if and when you sell the home, or how strict or forgiving an examiner will be with your cost basis adjustments.  I can only suggest that you make a diligent effort to document as much of the cost basis as you can. You might want to take a few weeks to gather your records, make a spreadsheet listing the costs and the conversion rates, photographing or scanning the documents, and making a big electronic file that you back up wherever you back up other electronic files in case your computer crashes, or your house burns down.  Keep your records for as long as you own the house plus 3 years after you sell. 

One additional thought. Depending on the amount of government bureaucracy where this house is located, you might have had to file building permits or architects plans with the local government. The local government also might have reassessed the property value for property taxes every time you made an improvement. That would be another source of information about the cost or value of the improvements. It would not be a complete source, but it would be better than nothing. 

[Boomhauser]

Thank you @Opus 17 , you're a true Champ!

Regarding property taxes in my country, we don't have crazy property taxes like in the US.

I only pay to our local county a small tax fee once a year which can be as low as $200, so I'm not worry about it.

I also agree about being audited, it's a small probability, but I want to be prepared for it.

I also know that many people in my position wouldn't even report sale like that to the IRS, but not me, I want to sleep well at night.

I also have a few acres of land in my country, which I received from my father in the 80's. The basis in that land is almost zero, but now it's worth something. Are there same rules for sale of land? There is not much improvement you can do to a land, unless you build a house on it or some kind of structure. Your thoughts? Thank you.

[Opus 17]

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@Boomhauser wrote:

Thank you @Opus 17 , you're a true Champ!

Regarding property taxes in my country, we don't have crazy property taxes like in the US.

I only pay to our local county a small tax fee once a year which can be as low as $200, so I'm not worry about it.

I also agree about being audited, it's a small probability, but I want to be prepared for it.

I also know that many people in my position wouldn't even report sale like that to the IRS, but not me, I want to sleep well at night.

I also have a few acres of land in my country, which I received from my father in the 80's. The basis in that land is almost zero, but now it's worth something. Are there same rules for sale of land? There is not much improvement you can do to a land, unless you build a house on it or some kind of structure. Your thoughts? Thank you.

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Yes, the rules for unimproved land are the same.  "Property" is almost anything you can own, including personal property like clothes and books; intellectual property like copyrights and patents, and really, anything you can claim ownership of.  "Real property" means land and any structure that is permanently attached to the land.  The rules for calculating adjusted basis and capital gains on real property are the same whether or not there is a structure built on it.

Improvements to land can include the cost of installing public services (such as water, sewer and electricity) and the cost of surveying the land and preparing legal documents to subdivide it, if you were example planning to divide the lots and sell them to builders.  

[Boomhauser]

Thank you!

@Opus 17