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Question:

The original cost basis on a duplex purchased by Mr. Brown was $750,000. The tax assessor stated the breakdown of values to be 80% improvements and 20% land. Over the first five years, Mr. Brown depreciated the improvements at a rate of 2% each year. Mr. Brown then hired a licensed contractor to install a swimming pool at a cost of $50,000. Once the pool was completed, how much will the adjusted cost basis in the property be?

A b. $740,000.
Explaination

Depreciation can only be taken on the improvements (80%) portion of the purchase price. In this example: 80% x $750,000 = $600,000 (improvement portion of the original basis). $600,000 x 0.02 (2%) = $12,000 per year x 5 years = $60,000 (accrued depreciation). Then, subtract the accrued depreciation from the original cost basis. $750,000 (original cost basis) - $60,000 (accrued depreciation) = $690,000 (depreciated cost basis). Finally, add $50,000 for the new swimming pool improvement + $690,000 (depreciated cost basis) = $740,000 (adjusted cost basis).