Take it from Jovita Diaz. Diaz owned two properties, both of which were sold between 2007 and 2008.
Diaz purchased Property #1 in 1997 for $154,000. Upon selling Property #1 in 2007 for $459,000, Diaz claimed an adjusted tax basis of $553,000 and a resulting capital loss of $94,000. The IRS disallowed the loss, arguing that Diaz’ basis in Property #1 remained her original cost of $154,000, and thus the sale resulted in a $305,000 gain.
Property #2, a rental property, was purchased by Diaz in 2005 for $490,000. In June 2008, upon selling Property #2 for $299,000, Diaz claimed a basis of $595,000, resulting in a capital loss of $296,000. The IRS again challenged the loss, this time allowing depreciation against the acquisition cost in computing a tax basis in the rental property of $452,000, reducing the claimed capital loss to $153,000.
In both scenarios, Diaz argued that she had made significant improvements to each property: nearly $400,000 in the case of Property #1 and $100,000 for Property #2. In each case, the Tax Court held that Diaz failed up carry her burden of establishing her basis in the sold properties:
Petitioner did not introduce an invoice from the contractor, a canceled check, a construction permit for the improvements, or before and after pictures. Petitioner contended that she did not have documentation because she kept moving from one place to another. Her testimony was unpersuasive in support of her claim of [the] improvements.
The lesson is obvious. When reporting a sale from real estate, save all documents supporting not only your acquisition cost (such as a closing statement), but also those establishing the cost of any and all improvements made to the property. After all, it’s up to you to prove you spent what you say you did; it’s not up to the IRS to prove you didn’t.