Table of Contents
This chapter discusses how to figure your basis in property. It is divided into the following sections.
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Cost basis.
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Adjusted basis.
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Basis other than cost.
Your basis is the amount of your investment in property for tax purposes. Use the basis to figure gain or loss on the sale, exchange, or other disposition of property. Also use it to figure deductions for depreciation, amortization, depletion, and casualty losses.
If you use property for both business or investment purposes and for personal purposes, you must allocate the basis based on the use. Only the basis allocated to the business or investment use of the property can be depreciated.
Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property, increase your basis. If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis.
The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, other property, or services. Your cost also includes amounts you pay for the following items:
In addition, the basis of real estate and business assets may include other items.
Real property, also called real estate, is land and generally anything built on, growing on, or attached to land.
If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property.
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Abstract fees (abstract of title fees).
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Charges for installing utility services.
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Legal fees (including fees for the title search and preparation of the sales contract and deed).
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Recording fees.
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Survey fees.
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Transfer taxes.
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Owner's title insurance.
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Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.
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Casualty insurance premiums.
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Rent for occupancy of the property before closing.
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Charges for utilities or other services related to occupancy of the property before closing.
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Charges connected with getting a loan, such as points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender.
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Fees for refinancing a mortgage.
Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments (increases and decreases) to the cost of the property. The result is the adjusted basis.
Increase the basis of any property by all items properly added to a capital account. Examples of items that increase basis are shown in Table 13-1. These include the items discussed below.
Decrease the basis of any property by all items that represent a return of capital for the period during which you held the property. Examples of items that decrease basis are shown in Table 13-1. These include the items discussed below.
| Increases to Basis | Decreases to Basis | |
|---|---|---|
| • Capital improvements: | • Exclusion from income of | |
| Putting an addition on your home | subsidies for energy conservation | |
| Replacing an entire roof | measures | |
| Paving your driveway | ||
| Installing central air conditioning | • Casualty or theft loss deductions | |
| Rewiring your home | and insurance reimbursements | |
| • Assessments for local improvements: | ||
| Water connections | ||
| Extending utility service lines to the property |
• Postponed gain from the sale of a home | |
| Sidewalks | • Alternative motor vehicle credit (Form 8910) |
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| Roads | ||
| • Alternative fuel vehicle refueling | ||
| property credit (Form 8911) | ||
| • Residential energy credits (Form 5695) | ||
| • Casualty losses: | • Depreciation and section 179 deduction | |
| Restoring damaged property | ||
| • Nontaxable corporate distributions | ||
| • Legal fees: | ||
| Cost of defending and perfecting a title | • Certain canceled debt excluded from | |
| Fees for getting a reduction of an assessment | income | |
| • Zoning costs | • Easements | |
| • Adoption tax benefits | ||
Example.
You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. You added an improvement to the duplex that cost $10,000. In February last year, the duplex was damaged by fire. Up to that time, you had been allowed depreciation of $23,000. You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. You deducted a casualty loss of $1,000 on your income tax return for last year. You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this year. You must use the duplex's adjusted basis after the restoration to determine depreciation for the rest of the property's recovery period. Figure the adjusted basis of the duplex as follows:
| Original cost of duplex | $35,000 | ||
| Addition to duplex | 10,000 | ||
| Total cost of duplex | $45,000 | ||
| Minus: | Depreciation | 23,000 | |
| Adjusted basis before casualty | $22,000 | ||
| Minus: | Insurance proceeds | $19,700 | |
| Deducted casualty loss | 1,000 | ||
| Salvage proceeds | 1,300 | 22,000 | |
| Adjusted basis after casualty | $-0- | ||
| Add: Cost of restoring duplex | 19,000 | ||
| Adjusted basis after restoration | $19,000 | ||
There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of the property can be used. Fair market value (FMV) and adjusted basis were discussed earlier.
If you receive property for your services, include its FMV in income. The amount you include in income becomes your basis. If the services were performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary.
A taxable exchange is one in which the gain is taxable or the loss is deductible. A taxable gain or deductible loss also is known as a recognized gain or loss. If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange.
If you receive replacement property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the replacement property using the basis of the converted property.
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Decrease the basis by the following.
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Any loss you recognize on the involuntary conversion.
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Any money you receive that you do not spend on similar property.
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Increase the basis by the following.
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Any gain you recognize on the involuntary conversion.
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Any cost of acquiring the replacement property.
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Example.
The state condemned your property. The adjusted basis of the property was $26,000 and the state paid you $31,000 for it. You realized a gain of $5,000 ($31,000 − $26,000). You bought replacement property similar in use to the converted property for $29,000. You recognize a gain of $2,000 ($31,000 − $29,000), the unspent part of the payment from the state. Your unrecognized gain is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. The basis of the replacement property is figured as follows:
| Cost of replacement property | $29,000 |
| Minus: Gain not recognized | 3,000 |
| Basis of replacement property | $26,000 |
A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. If you receive property in a nontaxable exchange, its basis is generally the same as the basis of the property you transferred. See Nontaxable Trades in chapter 14.
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To qualify as a like-kind exchange, the property traded and the property received must be both of the following.
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Qualifying property.
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Like-kind property.
The basis of the property you receive is generally the same as the adjusted basis of the property you gave up. If you trade property in a like-kind exchange and also pay money, the basis of the property received is the adjusted basis of the property you gave up increased by the money you paid.
Example.
You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. The dealer allows you $2,000 on the old truck, and you pay $4,800. This is a like-kind exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800).
If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of $300 on the sale (the $2,000 sale price minus the $1,700 adjusted basis). The basis of the new truck is the price you pay the dealer.
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Decrease the basis by the following amounts.
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Any money you receive.
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Any loss you recognize on the exchange.
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Increase the basis by the following amounts.
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Any additional costs you incur.
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Any gain you recognize on the exchange.
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The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse that is incident to divorce. However, for property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed, plus the liabilities to which the property is subject, are more than the adjusted basis of the property transferred.
If the property transferred to you is a series E, series EE, or series I U.S. savings bond, the transferor must include in income the interest accrued to the date of transfer. Your basis in the bond immediately after the transfer is equal to the transferor's basis increased by the interest income includible in the transferor's income. For more information on these bonds, see chapter 7.
At the time of the transfer, the transferor must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer.
For more information about the transfer of property from a spouse, see chapter 14.
To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its FMV at the time it was given to you, and any gift tax paid on it.
Example.
You received an acre of land as a gift. At the time of the gift, the land had an FMV of $8,000. The donor's adjusted basis was $10,000. After you received the property, no events occurred to increase or decrease your basis. If you later sell the property for $12,000, you will have a $2,000 gain because you must use the donor's adjusted basis at the time of the gift ($10,000) as your basis to figure gain. If you sell the property for $7,000, you will have a $1,000 loss because you must use the FMV at the time of the gift ($8,000) as your basis to figure loss.
If the sales price is between $8,000 and $10,000, you have neither gain nor loss.
Example.
In 2011, you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. The amount of the gift for gift tax purposes was $37,000 ($50,000 minus the $13,000 annual exclusion). She paid a gift tax of $7,540 on the property. Your basis is $26,107, figured as follows:
| Fair market value | $50,000 |
| Minus: Adjusted basis | −20,000 |
| Net increase in value | $30,000 |
| Gift tax paid | $7,540 |
| Multiplied by ($30,000 ÷ $37,000) | × .81 |
| Gift tax due to net increase in value | $6,107 |
| Adjusted basis of property to your mother | +20,000 |
| Your basis in the property | $26,107 |
If you inherited property from a decedent who died before 2010, your basis in property you inherit from a decedent is generally one of the following.
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The FMV of the property at the date of the decedent's death.
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The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate valuation.
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The value under the special-use valuation method for real property used in farming or a closely held business if elected for estate tax purposes.
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The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement.
If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.
For more information, see the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.
Example.
You and your spouse owned community property that had a basis of $80,000. When your spouse died, half the FMV of the community interest was includible in your spouse's estate. The FMV of the community interest was $100,000. The basis of your half of the property after the death of your spouse is $50,000 (half of the $100,000 FMV). The basis of the other half to your spouse's heirs is also $50,000.
For more information about community property, see Publication 555, Community Property.
If you hold property for personal use and then change it to business use or use it to produce rent, you can begin to depreciate the property at the time of the change. To do so, you must figure its basis for depreciation. An example of changing property held for personal use to business or rental use would be renting out your former personal residence.
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The FMV of the property on the date of the change.
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Your adjusted basis on the date of the change.
Example.
Several years ago, you paid $160,000 to have your house built on a lot that cost $25,000. You paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house before changing the property to rental use last year. Because land is not depreciable, you include only the cost of the house when figuring the basis for depreciation.
Your adjusted basis in the house when you changed its use was $178,000 ($160,000 + $20,000 − $2,000). On the same date, your property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. The basis for figuring depreciation on the house is its FMV on the date of the change ($165,000) because it is less than your adjusted basis ($178,000).
Example.
Assume the same facts as in the previous example, except that you sell the property at a loss after being allowed depreciation deductions of $37,500. In this case, you would start with the FMV on the date of the change to rental use ($180,000), because it is less than the adjusted basis of $203,000 ($178,000 + $25,000 (land)) on that date. Reduce that amount ($180,000) by the depreciation deductions ($37,500). The basis for loss is $142,500 ($180,000 − $37,500).
The basis of stocks or bonds you buy generally is the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. If you get stocks or bonds other than by purchase, your basis is usually determined by the FMV or the previous owner's adjusted basis, as discussed earlier.
You must adjust the basis of stocks for certain events that occur after purchase. For example, if you receive additional stock from nontaxable stock dividends or stock splits, reduce your basis for each share of stock by dividing the adjusted basis of the old stock by the number of shares of old and new stock. This rule applies only when the additional stock received is identical to the stock held. Also reduce your basis when you receive nontaxable distributions. They are a return of capital.
Example.
In 2009 you bought 100 shares of XYZ stock for $1,000 or $10 a share. In 2010 you bought 100 shares of XYZ stock for $1,600 or $16 a share. In 2011 XYZ declared a 2-for-1 stock split. You now have 200 shares of stock with a basis of $5 a share and 200 shares with a basis of $8 a share.