Basis Is Everything: A Pre-Sale Real Estate Guide

The Tax Records Luxury Homeowners Should Be Keeping

1. The Acquisition File

Your basis begins with the original purchase, and the settlement statement is its foundation. Beyond the price, it shows costs that belong in basis: title insurance, recording and legal fees, and your share of the realty transfer tax.

That last item is routinely overlooked. Delaware's transfer tax is among the highest in the country, typically 4% combined and customarily split evenly between buyer and seller. A buyer who paid 2% on a $1.2 million purchase added $24,000 to basis.

For homes built rather than bought, a common path in coastal Sussex, the file is larger:

• The lot purchase settlement statement
• The construction contract and every executed change order
• Draw schedules and proof of payment to the builder
• Permit, impact, tap and utility connection fees
• Architect, engineering and survey invoices

If the home came to you by gift, you generally inherit the donor's basis, so their records become yours to locate. If it was inherited, the date-of-death appraisal establishes your starting point.

2. Capital Improvements: Where Coastal Homes Earn Their Basis

The distinction that matters is between an improvement, which adds value, extends useful life or adapts the property to a new use, and a repair, which simply maintains it. Improvements raise basis; repairs do not.

Coastal properties tend to accumulate exactly the kind of costly, durable work that qualifies:

• Waterfront structures: bulkheads, riprap, living shorelines, docks, piers and boat lifts
• Flood resilience: elevating the home, flood vents, breakaway walls, relocating mechanicals above base flood elevation
• Storm hardening: impact-rated windows and doors, roof replacement, permanent shutters, whole-house generators
• Expansion and amenities: additions, finished lower levels, pools, outdoor kitchens, screened porches, hardscape and permanent landscaping
• Systems: full HVAC replacement, new plumbing or electrical service, solar installations

For each project, keep the contract, the final invoice and proof of payment. A building permit from the county or town is valuable corroboration of what was done and when.

Two adjustments work against you. Insurance proceeds and any casualty loss you deducted after a storm reduce basis. So do federal energy credits claimed for qualifying installations. Your records should capture both.

3. Rental History: The Second-Home Trap

A familiar coastal Sussex story: a family buys a beach house, rents it for summer weeks, uses it on weekends, and eventually retires there full time. That path is entirely sensible, but it carries two tax consequences that catch sophisticated owners off guard.

• Depreciation recapture. Depreciation on rental use after May 6, 1997 is taxed at up to 25% when you sell, and the home-sale exclusion does not shelter it. Basis is reduced by the depreciation you were entitled to take, whether or not you actually claimed it.
• Nonqualified use. For periods after 2008 when the home was a rental or second home rather than your principal residence, a proportional share of the gain is ineligible for the exclusion. Consider a couple who owned for ten years, rented for the first six and lived there for the last four. Only about 40% of their gain is eligible for the exclusion, before any recapture.

The records that matter here are prior-year tax returns with their depreciation schedules, rental agency statements, and documentation of the date the property became your primary home.

A home that was never your principal residence does not qualify for the exclusion at all. For higher-income sellers, gain above any exclusion may also carry the 3.8% net investment income tax. For a property held strictly as a rental, a 1031 exchange may be worth evaluating, and it depends on the same records.

4. Residency: Proof, and Delaware's Form 5403

Many of our owners divide the year between the coast and a home in Maryland, Pennsylvania, New Jersey, Virginia or Washington, D.C. That raises two questions at sale time.

The first is which property is your principal residence. The answer rests on facts: where you spend most of your time, the address on your driver's license, voter registration and tax returns, and where you bank and see your physicians. If you intend to claim the exclusion on a Delaware home, build that record deliberately.

The second is Delaware residency at settlement. Every seller of Delaware real estate completes Form 5403 at recording. Nonresident sellers must also remit estimated Delaware income tax on the gain at that moment, calculated at the highest marginal rate.

This is where weak records become an immediate cash cost. If your basis is understated, the estimated payment withheld from your proceeds is overstated. You can recover the excess on your Delaware nonresident return, but your capital is tied up in the meantime. Having basis documented before settlement lets your CPA prepare the 5403 on your true gain.

5. The Sale Itself: Costs That Reduce Your Gain

The costs of selling reduce the amount you realize, and therefore your gain. At the luxury end of our market, they are substantial.

The seller's half of the realty transfer tax is the clearest example. At a customary 2%, it represents $50,000 on a $2.5 million sale. Add brokerage commission, settlement and legal fees, and any seller credits negotiated during inspection.

The final Closing Disclosure captures most of this, but keep separate invoices for costs paid outside settlement, such as legal review or pre-listing preparation your CPA considers part of the sale.

6. Ownership Structure and Estate Basis

Records outlast the people who created them, so they deserve a place in estate planning.

Delaware is not a community property state. When a spouse dies, generally only the decedent's half of a jointly owned home receives a stepped-up basis. The surviving spouse's half keeps its original basis, which means the improvement file still matters for a later sale. A surviving spouse may still claim the full $500,000 exclusion if the home is sold within two years of the death and the other requirements were met.

If the property is held in a revocable trust, the exclusion is generally preserved. If a rental sits in an LLC or other entity, keep the operating agreement and entity returns alongside the property file, since they govern how gain is reported.

For heirs, a qualified date-of-death appraisal is the single most important document. Obtain it promptly, while comparable sales are easy to establish.

Your Pre-Sale Records Checklist

• Original settlement statement, or lot and construction records for a custom build
• Contracts, invoices, proof of payment and permits for every capital improvement
• Insurance claim files and any casualty loss deductions
• Federal energy credits claimed on the property
• Prior-year returns with depreciation schedules for any rental years
• Rental agency statements and the date the home became your primary residence
• Evidence of domicile: license, voter registration, tax return addresses
• Trust, LLC and title documents; any date-of-death appraisal

A Word on Timing

The best time to assemble this file is now, not at the listing appointment. Reconstructing fifteen years of improvements from bank statements and contractor memory is possible, but it is slow and the result is weaker. A sale that is two or three years away gives you time to fill gaps and to plan with your CPA around the exclusion, residency and recapture. This article is general information, not tax or legal advice. Please consult your CPA or tax attorney about your specific situation.

When you are ready to talk about value, I am happy to bring the market side of that conversation. -Henry