Cost Basis after Cash Purchase

[Frank S.]

Hi BP, 

I read "Every Landlord's Tax Deduction Guide" by NOLO, great book.  I have a question regarding the cost basis for a property. 

Purchased:  69K, mid year during the tax year. Market value was about 85K.

Tax Assessment: 172 K (The city is nuts!)  I contested this and the tax was temporarily lowered to 40K.  They raised again to 172K.

Repairs took place over two tax years, I will ignore second tax year for now:  Tax year 1-  30 K in capital improvements. 

Total cost out of pocket:  99K. No mortgage, I refinanced after completion (tax year 2)

What would you use as the cost basis? 

My account indicates "purchased price plus capital improvements."  However, the property was purchased at a discount.  Can I use fair market value and tax assessment instead of actual cost?   The difference over 27.5 years is not that much, but I don't necessary agree with them. 

Imagine if you get a property at a heavy discount, or even inherited? How is the cost basis establish, then? 

Now, imagine if you overpay for a property, will the IRS allow you to depreciate the much larger cost or will they claim that you have a cap according to the fair market value and tax assessment?

Thanks, 

Frank