Table of Contents
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.
-
Sales tax.
-
Freight.
-
Installation and testing.
-
Excise taxes.
-
Legal and accounting fees (when they must be capitalized).
-
Revenue stamps.
-
Recording fees.
-
Real estate taxes (if assumed for the seller).
You may also have to capitalize certain other costs related to buying or producing property.
The basis of stocks or bonds you buy is generally 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 fair market value (FMV) or the previous owner's adjusted the basis of stock.
You must adjust the basis of stocks for certain events that occur after purchase. See Stocks and Bonds in chapter 4 of Publication 550 for more information on the basis of stock.
If you buy real property, certain fees and other expenses become part of your cost basis in the property.
-
Abstract fees (abstract of title fees).
-
Charges for installing utility services.
-
Legal fees (including title search and preparation of the sales contract and deed).
-
Recording fees.
-
Surveys.
-
Transfer taxes.
-
Owner's title insurance.
-
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.
-
Fire insurance premiums.
-
Rent for occupancy of the property before closing.
-
Charges for utilities or other services related to occupancy of the property before closing.
-
Charges connected with getting a loan. The following are examples of these charges.
-
Points (discount points, loan origination fees).
-
Mortgage insurance premiums.
-
Loan assumption fees.
-
Cost of a credit report.
-
Fees for an appraisal required by a lender.
-
-
Fees for refinancing a mortgage.
-
Cost of the land.
-
Cost of labor and materials.
-
Architect's fees.
-
Building permit charges.
-
Payments to contractors.
-
Payments for rental equipment.
-
Inspection fees.
-
Employee wages paid for the construction work.
-
Depreciation on equipment you own while it is used in the construction.
-
Operating and maintenance costs for equipment used in the construction.
-
The cost of business supplies and materials used in the construction.
| Amortization |
| Capitalization |
| Depletion |
| Depreciation |
| Fair market value |
| Going concern value |
| Goodwill |
| Intangible property |
| Personal property |
| Recapture |
| Section 179 deduction |
| Section 197 intangibles |
| Tangible property |
If you purchase property to use in your business, your basis is usually its actual cost to you. If you construct, create, or otherwise produce property, you must capitalize the costs as your basis. In certain circumstances, you may be subject to the uniform capitalization rules, next.
The uniform capitalization rules specify the costs you add to basis in certain circumstances.
-
Produce real or tangible personal property for use in the business or activity.
-
Produce real or tangible personal property for sale to customers.
-
Acquire property for resale.
-
Property you produce that you do not use in your trade, business, or activity conducted for profit.
-
Qualified creative expenses you pay or incur as a free-lance (self-employed) writer, photographer, or artist that are otherwise deductible on your tax return.
-
Property you produce under a long-term contract, except for certain home construction contracts.
-
Research and experimental expenses allowable as a deduction under section 174 of the Internal Revenue Code.
-
Costs for personal property acquired for resale if your (or your predecessor's) average annual gross receipts for the 3 previous tax years do not exceed $10 million.
Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises. The basis of an intangible asset is usually the cost to buy or create it. If you acquire multiple assets, for example a going business for a lump sum, see Allocating the Basis, later, to figure the basis of the individual assets. The basis of certain intangibles can be amortized. See chapter 9 of Publication 535 for information on the amortization of these costs.
If you buy multiple assets for a lump sum, allocate the amount you pay among the assets you receive. You must make this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets. See Trade or Business Acquired, later.
If you buy multiple assets for a lump sum, you and the seller may agree to a specific allocation of the purchase price among the assets in the sales contract. If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted. However, see Trade or Business Acquired, next.
If you acquire a trade or business, allocate the consideration paid to the various assets acquired. Generally, reduce the consideration paid by any cash and general deposit accounts (including checking and savings accounts) received. Allocate the remaining consideration to the other business assets received in proportion to (but not more than) their fair market value in the following order.
-
Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and securities.
-
Accounts receivable, other debt instruments, and assets you mark to market at least annually for federal income tax purposes.
-
Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held primarily for sale to customers in the ordinary course of business.
-
All other assets except section 197 intangibles, goodwill, and going concern value.
-
Section 197 intangibles except goodwill and going concern value.
-
Goodwill and going concern value (whether or not they qualify as section 197 intangibles).
If you buy buildings and the land on which they stand for a lump sum, allocate the basis of the property among the land and the buildings so you can figure the depreciation allowable on the buildings.
Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase. If you are not certain of the FMV of the land and buildings, you can allocate the basis based on their assessed values for real estate tax purposes.
-
75 percent or more of the existing external walls of the building are retained in place as internal or external walls.
-
75 percent or more of the existing internal structural framework of the building is retained in place.
Example.
You bought a tract of land to which you assigned a cost of $15,000. You subdivided the land into 15 building lots of equal size and equitably divided your basis so that each lot had a basis of $1,000. You treated the sale of each lot as a separate transaction and figured gain or loss separately on each sale.
Several years later you determine that your original basis in the tract was $22,500 and not $15,000. You sold eight lots using $8,000 of basis in years for which the statute of limitations has expired. You now can take $1,500 of basis into account for figuring gain or loss only on the sale of each of the remaining seven lots ($22,500 basis divided among all 15 lots). You cannot refigure the basis of the eight lots sold in tax years barred by the statute of limitations.
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 to the basis of the property. The result of these adjustments to the basis is the adjusted basis.
Increase the basis of any property by all items properly added to a capital account. These include the cost of any improvements having a useful life of more than 1 year.
Rehabilitation expenses also increase basis. However, you must subtract any rehabilitation credit allowed for these expenses before you add them to your basis. If you have to recapture any of the credit, increase your basis by the recaptured amount.
If you make additions or improvements to business property, keep separate accounts for them. Also, you must depreciate the basis of each according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. For more information, see Publication 946.
The following items increase the basis of property.
-
The cost of extending utility service lines to the property.
-
Impact fees.
-
Legal fees, such as the cost of defending and perfecting title.
-
Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements.
-
Zoning costs.
-
The capitalized value of a redeemable ground rent.
Increase the basis of property by assessments for items such as paving roads and building ditches that increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes charges for maintenance, repairs, or interest charges related to the improvements.
Do not add to your basis costs you can deduct as current expenses. For example, amounts paid for incidental repairs or maintenance that are deductible as business expenses cannot be added to basis. However, you can choose either to deduct or to capitalize certain other costs. If you capitalize these costs, include them in your basis. If you deduct them, do not include them in your basis. (See Uniform Capitalization Rules, earlier.)
The costs you can choose to deduct or to capitalize include the following.
-
Carrying charges, such as interest and taxes, that you pay to own property, except carrying charges that must be capitalized under the uniform capitalization rules.
-
Research and experimentation costs.
-
Intangible drilling and development costs for oil, gas, and geothermal wells.
-
Exploration costs for new mineral deposits.
-
Mining development costs for a new mineral deposit.
-
Costs of establishing, maintaining, or increasing the circulation of a newspaper or other periodical.
-
Cost of removing architectural and transportation barriers to people with disabilities and the elderly. If you claim the disabled access credit, you must reduce the amount you deduct or capitalize by the amount of the credit.
For more information about deducting or capitalizing costs, see chapter 8 in Publication 535.
Table 1. Examples of Increases and Decreases to Basis
| Increases to Basis | Decreases to Basis |
| Capital improvements:
Putting an addition on your home Replacing an entire roof Paving your driveway Installing central air conditioning Rewiring your home |
Exclusion from income of subsidies for energy conservation measures
Casualty or theft loss deductions and insurance reimbursements Credit for qualified electric vehicles |
| Assessments for local improvements:
Water connections Sidewalks Roads |
Section 179 deduction
Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property |
| Casualty losses:
Restoring damaged property |
Depreciation
Nontaxable corporate distributions |
| Legal fees:
Cost of defending and perfecting a title |
|
| Zoning costs |
Table 1. Examples of Increases and Decreases to Basis
| Increases to Basis | Decreases to Basis |
| Capital improvements:
Putting an addition on your home Replacing an entire roof Paving your driveway Installing central air conditioning Rewiring your home |
Exclusion from income of subsidies for energy conservation measures
Casualty or theft loss deductions and insurance reimbursements Credit for qualified electric vehicles |
| Assessments for local improvements:
Water connections Sidewalks Roads |
Section 179 deduction
Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property |
| Casualty losses:
Restoring damaged property |
Depreciation
Nontaxable corporate distributions |
| Legal fees:
Cost of defending and perfecting a title |
|
| Zoning costs |
The following items reduce the basis of property.
-
Section 179 deduction.
-
Deduction for clean-fuel vehicles and refueling property.
-
Nontaxable corporate distributions.
-
Deductions previously allowed (or allowable) for amortization, depreciation, and depletion.
-
Exclusion of subsidies for energy conservation measures.
-
Credit for qualified electric vehicles.
-
Postponed gain from sale of home.
-
Investment credit (part or all) taken.
-
Casualty and theft losses and insurance reimbursements.
-
Certain canceled debt excluded from income.
-
Rebates from a manufacturer or seller.
-
Easements.
-
Gas-guzzler tax.
-
Tax credit or refund for buying a diesel-powered highway vehicle.
-
Adoption tax benefits.
-
Credit for employer-provided child care.
Some of these items are discussed next.
If you have a casualty or theft loss, decrease the basis in your property by any insurance or other reimbursement and by any deductible loss not covered by insurance.
You must increase your basis in the property by the amount you spend on repairs that substantially prolong the life of the property, increase its value, or adapt it to a different use. To make this determination, compare the repaired property to the property before the casualty. For more information on casualty and theft losses, see Publication 547, Casualties, Disasters, and Thefts.
The amount you receive for granting an easement is generally considered to be a sale of an interest in real property. It reduces the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain.
If you claim the credit for a qualified electric vehicle, you must reduce your basis in that vehicle by the maximum credit allowable even if the credit allowed is less than that maximum amount. For information on this credit, see chapter 12 in Publication 535.
Decrease the basis in your car by the gas-guzzler (fuel economy) tax if you begin using the car within 1 year of the date of its first sale for ultimate use. This rule also applies to someone who later buys the car and begins using it not more than 1 year after the original sale for ultimate use. If the car is imported, the one-year period begins on the date of entry or withdrawal of the car from the warehouse if that date is later than the date of the first sale for ultimate use.
If you take the section 179 deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction. For more information about the section 179 deduction, see Publication 946.
If you take the deduction for clean-fuel vehicles or clean-fuel vehicle refueling property, decrease the basis of the property by the amount of the deduction. For more information about these deductions, see chapter 12 in Publication 535.
You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of any energy conservation measure for a dwelling unit. Reduce the basis of the property for which you received the subsidy by the excluded amount. For more information on this subsidy, see Publication 525.
Decrease the basis of property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. If you took less depreciation than you could have under the method chosen, decrease the basis by the amount you could have taken under that method. If you did not take a depreciation deduction, reduce the basis by the full amount of the depreciation you could have taken.
Unless a timely election is made not to deduct the special depreciation allowance for property placed in service after September 10, 2001, decrease the property's basis by the special depreciation allowance you deducted or could have deducted.
If you deducted more depreciation than you should have, decrease your basis by the amount equal to the depreciation you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for the year.
In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation capitalized under the uniform capitalization rules.
For information on figuring depreciation, see Publication 946.
If you are claiming depreciation on a business vehicle, see Publication 463. If the car is not used more than 50% for business during the tax year, you may have to recapture excess depreciation. Include the excess depreciation in your gross income and add it to your basis in the property. For information on the computation of excess depreciation, see chapter 4 in Publication 463.
If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
You can exclude canceled debt from income in the following situations.
-
Debt canceled in a bankruptcy case or when you are insolvent.
-
Qualified farm debt.
-
Qualified real property business debt (provided you are not a C corporation).
If you exclude from income canceled debt under situation (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. However, in situation (3), you must reduce the basis of your depreciable property by the excluded amount.
For more information about canceled debt in a bankruptcy case or during insolvency, see Publication 908, Bankruptcy Tax Guide. For more information about canceled debt that is qualified farm debt, see chapter 4 in Publication 225. For more information about qualified real property business debt, see chapter 5 in Publication 334, Tax Guide for Small Business.
If you postponed gain from the sale of your main home before May 7, 1997, you must reduce the basis of your new home by the postponed gain. For more information on the rules for the sale of a home, see Publication 523.
If you claim an adoption credit for the cost of improvements you added to the basis of your home, decrease the basis of your home by the credit allowed. This also applies to amounts you received under an employer's adoption assistance program and excluded from income. For more information on these benefits, see Publication 968, Tax Benefits for Adoption.
In January 1997, you paid $80,000 for real property to be used as a factory. You also paid commissions of $2,000 and title search and legal fees of $600. You allocated the total cost of $82,600 between the land and the building—$10,325 for the land and $72,275 for the building. Immediately you spent $20,000 in remodeling the building before you placed it in service. You were allowed depreciation of $14,526 for the years 1997 through 2001. In 2000 you had a $5,000 casualty loss from a fire that was not covered by insurance on the building. You claimed a deduction for this loss. You spent $5,500 to repair the fire damages and extend the useful life of the building. The adjusted basis of the building on January 1, 2002, is figured as follows:
| Original cost of building including fees and commissions | $72,275 | ||
| Adjustments to basis: | |||
| Add: | |||
| Improvements | 20,000 | ||
| Repair of fire damages | 5,500 | ||
| $97,775 | |||
| Subtract: | |||
| Depreciation | $14,526 | ||
| Deducted casualty loss | 5,000 | 19,526 | |
| Adjusted basis on January 1, 2002 | $78,249 | ||
The basis of the land, $10,325, remains unchanged. It is not affected by any of the above adjustments.
There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of property may be used. Adjusted basis is discussed earlier.
If you receive property for services, include the property's 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 bargain purchase is a purchase of an item for less than its FMV. If, as compensation for services, you purchase goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in your income. Your basis in the property is its FMV (your purchase price plus the amount you include in income).
If the difference between your purchase price and the FMV represents a qualified employee discount, do not include the difference in income. However, your basis in the property is still its FMV. See Employee Discounts in Publication 15–B, Employer's Tax Guide to Fringe Benefits.
If you receive property for your services and the property is subject to certain restrictions, your basis in the property is its FMV when it becomes substantially vested unless you make the election discussed later. Property becomes substantially vested when your rights in the property or the rights of any person to whom you transfer the property are not subject to a substantial risk of forfeiture.
There is substantial risk of forfeiture when the rights to full enjoyment of the property depend on the future performance of substantial services by any person.
When the property becomes substantially vested, include the FMV, less any amount you paid for the property, in income.
Example.
Your employer gives you stock for services performed under the condition that you will have to return the stock unless you complete 5 years of service. The stock is under a substantial risk of forfeiture and is not substantially vested when you receive it. You do not report any income until you have completed the 5 years of service that satisfy the condition.
Example.
You received stock from your employer for services you performed. If you want to sell the stock while you are still employed, you must sell the stock to your employer at book value. At your retirement or death, you or your estate must offer to sell the stock to your employer at its book value. This is a restriction that by its terms will never end and you must consider it when you figure the FMV.
A taxable exchange is one in which the gain is taxable or the loss is deductible. A taxable gain or deductible loss is also known as a recognized gain or loss. If you receive property in exchange for other property in a taxable exchange, the basis of property you receive is usually its FMV at the time of the exchange. A taxable exchange occurs when you receive cash or property not similar or related in use to the property exchanged.
Example.
You trade a tract of farm land with an adjusted basis of $3,000 for a tractor that has an FMV of $6,000. You must report a taxable gain of $3,000 for the land. The tractor has a basis of $6,000.
If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, you can figure the basis of the replacement property you receive using the basis of the converted property.
-
Decrease the basis by the following.
-
Any loss you recognize on the conversion.
-
Any money you receive that you do not spend on similar property.
-
-
Increase the basis by the following.
-
Any gain you recognize on the conversion.
-
Any cost of acquiring the replacement property.
-
Example.
The state condemned your property. The property had an adjusted basis of $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 gain not recognized is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. The basis of the new property is figured as follows:
| Cost of replacement property | $29,000 |
| Minus: Gain not recognized | 3,000 |
| Basis of the replacement property | $26,000 |
| Intangible property |
| Like-kind property |
| Personal property |
| Real property |
| Tangible property |
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 usually the same as the basis of the property you transferred. A nontaxable gain or loss is also known as an unrecognized gain or loss.
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, you must hold for business or investment purposes both the property you transfer and the property you receive. There must also be an exchange of like-kind property. For more information, see Like-Kind Exchanges in Publication 544.
The basis of the property you receive is the same as the basis of the property you gave up.