Cost Basis

Cost basis is the original value of an asset for tax purposes, usually the purchase price plus certain acquisition costs and capital improvements. It is related to cash invested in a cash on cash calculation but is not the same number, because basis includes the borrowed part of the price.

On the default deal, cash invested is $150,000: the down payment, closing costs and rehab. The cost basis starts near $500,000 plus capitalizable closing costs and the $10,000 of improvements. The mortgage adds to basis but never to cash invested.

Basis is split between land and building, and only the building is depreciated. Each year's depreciation lowers the adjusted basis, which raises the taxable gain at sale. Keep records of improvements from the start, since they raise basis and reduce that eventual tax.

Further reading: Cost Basis on Wikipedia.