Need help calculating Cost Basis of Investment Property with rehab expenses for tax return

Thanks for the detailed response! I have a follow-up question. I did some of the work myself (painting, landscaping, etc.) - can I include my own labor hours as part of the cost basis? Also, if the IRS questions my renovation expenses, what's the worst that could happen if I can't produce receipts for everything?

Unfortunately, you cannot include the value of your own labor in your cost basis. The IRS only allows you to add actual money spent on materials, contractor labor, and related expenses - not the value of your personal time and effort, regardless of how substantial it was. If the IRS questions your renovation expenses and you can't produce receipts for everything, they might disallow those unsupported expenses, which would increase your taxable gain. They could also potentially assess penalties and interest on any resulting underpayment of tax. This is why it's important to gather as much alternative documentation as possible for expenses without receipts - bank statements showing payments to contractors or home improvement stores, before/after photos, contractor agreements, etc. Having a reasonable explanation for the missing documentation also helps demonstrate good faith.

How accurate is this service? I'm in a similar situation but with multiple properties and renovations. Does it actually work with bank statements? My contractor was paid in several installments and I'm having trouble matching which payment went to which project.

I'm pretty skeptical of these online tools. Wouldn't a CPA who specializes in real estate be better? I've heard horror stories of people using software then getting audited because they missed something important.

The service is surprisingly accurate. It uses some kind of AI to analyze your statements and can identify patterns that help categorize expenses even across multiple properties. For your situation with payments to the same contractor across different projects, you can add notes or tags to help the system differentiate them, or upload any contracts that show the payment schedule for each project. A real estate CPA is definitely valuable, but they typically charge $300-500/hour for this kind of detailed cost basis analysis. I actually had my CPA review the report from taxr.ai afterward, and he was impressed with how thorough it was. The system catches things that are easy to miss, especially when you have thousands of transactions to sort through. That said, having a professional review is always a good idea for complex situations.

Does this actually work? The IRS phone system is notoriously terrible. How much does it cost? Seems too good to be true honestly.

I don't buy it. No way some third-party service has special access to the IRS phone lines. Plus, even if you get through, the agents give different answers depending on who you talk to. I called three times about a similar issue and got three completely different responses.

Yes, it absolutely works! It doesn't give you special access to different IRS lines - it just automates the hold process. Basically, their system calls the IRS and navigates through all the prompts, then waits on hold so you don't have to. When a human agent is about to pick up, it calls you and connects the calls. You're right that IRS agents sometimes give different answers. That's why I like to call multiple times to verify information. But it's impossible to do that when each call means 2+ hours on hold! With this service, I was able to speak with three different agents in a single afternoon to confirm the information about investment property basis calculations.

That's a great point I hadn't considered! Is there any specific guidance on how to distinguish between repairs and improvements in a major rehab situation? For example, I replaced all the flooring - some areas had damaged hardwood I replaced with new hardwood, other areas had old carpet I upgraded to luxury vinyl. Would both count as improvements?

In a major rehab of a distressed property, the IRS tends to be more favorable about classifying expenses as improvements rather than repairs. The key factors are whether the work adds value to the property, adapts it to a new use, or extends its useful life. Replacing flooring throughout would definitely count as a capital improvement, regardless of whether you're replacing hardwood with hardwood or carpet with luxury vinyl. You're substantially improving the property in both cases. Similarly, a new roof, updated electrical, plumbing upgrades, new HVAC, kitchen remodel, bathroom renovations - all these would be capital improvements that add to your basis. Even painting, which is normally considered a repair, can be classified as part of a capital improvement when it's done as part of a larger renovation project rather than as a standalone maintenance item.

Not a silly question at all! The "dealer" classification is about your overall pattern of activity, not just one property. Since OP mentioned this is their first sale, they have a W2 job, and they initially intended to rent it out (circumstances changed), they're unlikely to be classified as a dealer. The IRS looks at factors like: frequency of sales, extent of improvements, marketing efforts, and intent. A one-off situation where plans changed doesn't typically trigger dealer status. However, if you start doing this regularly, that's when you might need to worry about it!

This is incredibly helpful information, especially about the carrying costs during renovation! I completely forgot about the property taxes and insurance I paid during those 6 months - that's probably another $3-4k I can add to my basis. Quick question about the credit card documentation: I did use my personal credit card for a lot of Home Depot and contractor payments. Should I just print out those statements, or is there a specific way I need to organize them for the IRS? Also, if a single credit card transaction was for multiple things (like I bought materials for both the kitchen and bathroom in one trip), how detailed do I need to get in breaking that down? Thank you so much for mentioning this - every little bit helps reduce that capital gains hit!

For credit card statements, I'd recommend creating a simple spreadsheet that lists each relevant transaction with columns for: date, merchant, amount, and expense category (materials, labor, permits, etc.). You don't need to break down every single transaction to the penny - if you bought kitchen and bathroom materials in one Home Depot trip, you can just categorize it as "materials - interior renovation" or similar. The key is showing a clear paper trail and reasonable categorization. Print the credit card statements and keep them with your spreadsheet. If you have any photos of receipts on your phone (even blurry ones), include those too - every bit of documentation helps. One more thing - make sure to separate out any personal purchases that might be mixed in with renovation expenses on those same statements. The IRS won't appreciate seeing your grocery runs categorized as "construction materials"!